Stephen Jones: Growth outlook remains strong though inflation will still cause concern in 2022

At this time of year we tend to spend time looking back at the year gone by but also looking to what might await us in the year to come.

It would be relatively easy to paint a grim picture on either count. We know what the main issues are – a new Covid-19 strain, rising inflation and a typically long list of geopolitical concerns.

Let’s remind ourselves, however, that not all risks come to pass; if ever a quote was meant for the investment industry it is this one from Mark Twain: “I’ve been through some terrible things in my life, some of which actually happened.”

That is not to belittle the challenges we face, but it is a reminder that we often artificially elevate the level of risk confronting us and forget that where there are risks there are normally opportunities.

For example, 2021 may have been a difficult year in many respects but, as I write, the FTSE All-Share index is up more than 16 per cent for the year to date. Global equities (as measured by the MSCI World index) are up more than 24%.

So what do we think lies ahead for 2022?

Let’s start with perhaps that hardest prediction to make – the outlook for the Covid-19 pandemic.

The most recent lockdowns in Europe have certainly caused some concern and we await announcements of additional measures for the UK. However, if we assume the political hurdle for a return to complete lockdown remains high – and there is scope for scientists to address the worst fears of the new strain – then the Covid-19 outlook should return to being characterised

as a manageable threat, if one that still carries

a tragic toll.

In this scenario, we should reasonably expect the growth outlook to be strong enough to comfortably sustain corporate balance sheets

in 2022.

This brings us to the next potential risk – inflation and, subsequently, higher interest rates.

We all recognise the recent steep rise in prices across many goods and services and we expect this trend to remain in place during 2022 as we continue to battle with supply chain bottlenecks and labour shortages.

Central banks are likely, therefore, to tighten monetary policy, which means further raising of interest rates, particularly in the US and the UK. For government bond markets, which are more sensitive to higher rates, this means a challenging year awaits. Corporate bond markets are also likely to be subdued.

For equities, however, it could result in another robust year of returns.

Economic growth will be supported by strong gains in household income as both employment and wages continue to increase across many developed market economies. Equities typically perform well in the first years of a rate rising cycle (eg 2003/4 or 1994/5) with decent nominal growth offsetting the possibility of valuations de-rating. UK equities, in particular, start this phase with already low valuations and modest earning-per-share growth expectations.

Of course, runaway, persistent inflation is a much bigger concern, although we think inflation is more likely to temper its rise and begin to subside later in the year as supply constraints are reduced and labour mobility increases again.

In turn, this should limit how far central banks need to raise interest rates and how much long dated government bond yields need to rise.

Much of this “balanced” outlook depends on central banks not succumbing to a policy mistake either induced by their rhetoric or their actions. Judging by some mixed communications the Bank of England and others have released in recent months, this may well be a legitimate concern.

Persistent, higher, inflation would be a major shock after a decade of deflationary pressure and price data undershoots.

But, as Mark Twain might say, there are always risks if you care to think about them. For now, let’s enjoy the festive period.

Stephen Jones is UK chief executive at Aegon Asset Management.

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