Things Can Only Get Better

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12/01/2022
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As I write, in mid-December, the UK has just recoded the highest ever number of daily confirmed cases of Coronavirus, and the new Omicron variant is set to become the dominant strain within the UK. What we know so far is that this new strain seems more contagious than Delta, but also possibly less lethal. It is possible, just possible, that we may be past the worst with this virus, and that 2022 could be the year where things really get better.

Of course, that’s one of many possible outcomes for next year, but there are signs of hope if you choose to seek them out. Community mobility, as measured by Google, has unquestionably improved since the dark days of lockdown. Although mobility through workplaces and transit stations remains below the pre-pandemic norms, the underlying trend of mobility improvement is clear to see.

It seems likely that mobility may once again fall away as we brace with caution against this new strain, but the government zeitgeist seems to have changed, not just in the UK, but more broadly also. Barring any surprises in vaccine breakthrough, the prospect of further lockdowns appears to be falling rapidly, as countries move to live with, rather than live away from the virus threat. New growth possibilities should therefore emerge as we transition into this new phase.

That seems to be the view of policy makers too. Again, as I write, the Bank of England (BoE) has just announced a surprise rate increase to ¼ of a percent. That’s unlikely to do much in isolation, but it communicates a confident view of the recovering growth backdrop and increasing concern about high levels of inflation becoming persistent and ingrained within expectations. The BoE move follows closely on the very well telegraphed pivot from the US Federal reserve less than 12 hours before, where chair Powell has indicated the early withdrawal of liquidity support for markets and a steeper forecast path for higher interest rates in 2022 and 2023.

Stock markets seem to have taken this news on monetary policy well, and the increased assurance from policy makers on future economic growth is likely to dominate the rising cost of capital. Equities will likely remain the only game in town for many investors, with fixed income prospects remaining challenging for some time to come. While the new year will likely see yesterday’s winners within the equity space continue to outperform, policy makers have sewn the seeds for a possible style reversal within equity sectors.

Value stocks have underperformed their more growth orientated counterparts through most of the last cycle. One of the main features of that period of growth expansion was the low and falling level of bond yields. Interestingly, the US 10-year government bond yield, having reversed to almost 1.75% in early 2021, fell again on the run up to the US monetary policy announcement mentioned above. Fixed income markets seem to have been pricing for a policy mistake. The rise in bond yields that may eventually drive the reversal in fortunes of value stocks may still be some way off, but, perhaps more than at any other time in the past few years, it seems like a reasonably possibility in 2022 –see chart.

In practical terms, that may mean that the dominance of mega cap technology stocks may come under threat from the forgotten, and much cheaper, leisure and manufacturing sectors. That could take the form of a “recovery trade” in those names beaten up by the pandemic. As we slowly increase mobility, spending habits are also likely to change, with a lower proportion of disposable income spent on groceries and at online retail, and more on more usual amounts of travel and leisure. The patterns of future growth are also likely to change, prompting new winners within the equity space. That said, it really is hard to see overall stock market performance getting better than 2021. This next year may well turn out to be more about the security selection rather than the asset allocation.

US Value\Growth stocks versus 10-year bond yield.

US Value Growth stocks versus 10-year bond yield

Source: Refinitiv, SJP DFM Research December 2021

 

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