What can we expect in 2022? We spoke to various specialists to ask their thoughts, and inflation seems to be top of mind for all of them. None thinks it is “transitory”.
In Vanguard’s 2022 economic outlook, the firm notes that, “Central banks will have to maintain the delicate balance between keeping inflation expectations anchored and allowing for a supportive environment for economic growth. As negative supply shocks push inflation higher, they threaten to set off a self-fulfilling cycle of ever higher inflation, which could begin to chip away at demand.”
“As supply comes back, you will still have high demand which will fuel inflation,” says Philip Petursson, chief investment strategist at IG Wealth Management.
“Yes, the disruptions in the supply chain have an immediate effect on inflation”, agrees Anil Passi, managing director of global corporates at Morningstar. But propelling that demand at a more fundamental level, he considers, brews the huge mass of money that central banks across the world have issued since the start of the pandemic. “Central banks have ‘printed’ an increase of about 30% in the money supply,” he says.
Benoît Durocher, vice-president and chief economic strategist at Addenda Capital, also identifies the huge liquidities as the main culprit. “Inflation is a monetary phenomenon, where you have too much money floating around for a same level of goods and services production.” This time, there is a twist, brought on by the pandemic: too much money is running after a reduced supply of goods and services.
All three agree that by mid-2022, inflation will chug along above 3%, but “that is your best case scenario, notes Passi. The risk is that we will move up to 4%, even 5%, for the next few years.”
Where, O Where, is Income?
Which leads us to another theme linked to the previous one: finding income in an inflating world, as Petursson characterizes it. All three strategists agree that hard times are ahead for savers and that we have entered a bond bear market.
Year-to-date, the Scotia FTSE Canada Universe Bond index has moved negatively by -4.96%, with a 2.08% return at the end of last October, points out Durocher. But he also sounds an optimistic note: “At the end of last year, return to maturity was 1.2%.”
Those numbers mean that, with inflation running above 3%, bonds are a losing proposition for a portfolio. “Investors will have to look at alternative assets instead of bonds in order to preserve income and purchasing power, assets like dividend stocks, private debt and REITs,” says Petursson.
Call in the Inflation Tamer
The income conundrum leads into the third theme: what will central banks do and will they be able to tame inflation? The main lever to do that is raising central banks’ overnight rate, causing the whole bond yield curve to adjust upward. The situation in the U.S. is not yet clear, but in Canada, points out Durocher, “the Bank of Canada has said in October that it was interrupting its quantitative easing measures and expected to raise rates when excess capacity in the economy is spent, which leads us to the second or third quarter of 2022.” That will allow bond investors, in the long run, to renew with some level of return from their holdings and meanwhile cause portfolio managers to move to shorter durations.
However, that eventual move on the part of central banks causes Passi’s level of apprehension to rise. Because governments, corporations and individuals have taken on extra loads of debt in recent years, they could be very sensitive to rate increases when they happen. For example, asks Passi, what will rising rates do to housing? “Could that be the catalyst for the housing bubble to burst, or for the market to correct? Central banks have a very fine balancing act to perform between the possibility of letting inflation run out of control versus creating a housing and stock market crash.”
If central banks don’t pull off their balancing act, there could be more challenging times ahead. “Then, people will have to learn to live with inflation, Passi says. Some will benefit from wage increases, but others will lose purchasing power. There might be some government austerity down the road, raising taxes and cutting expenses.” He also notes that we will move from “pandemic to endemic” where people “will just have to learn to live with this; I don’t think we can afford a new lockdown. That could be a bit too bleak for people to handle.”
Not All Gloom and Doom
One final theme is more reassuring: the economic transition to normalisation. The year ahead will see a normalizing of the economic environment, Petursson believes – as long as the new Covid Omicron strain doesn’t derail everything. “We will need to stop thinking in terms of peak growth, he warns.” But, he quickly corrects: “Because we slow from the lofty levels of 2021 doesn’t mean that there will be no growth left, but it will not be as vigorous as last year.”
Passi expects to be alert to many structural changes that could settle in following the pandemic: whether work from home “will stick”, how much of the labour force will have permanently left, how companies will deal with such developments.
Petursson sees downside risk for the markets as “very limited” while equity markets “will see more average returns, in the 5% to 6% range. In 2020-21, gains came from price-earnings multiples expansion, but in 2022, we will move to earnings growth. In that environment, you want to be more selective and you need to identify the right companies that will give you that.”
The destination of choice will also change. “Next year, Petursson adds, I see Canada, emerging markets and Japan move to a better position from a valuation perspective, and we could see the U.S. underperform.”
