In its outlook for 2022, JP Morgan Asset Management makes no bones about the fact that equities remain attractive, even if inflation sticks around a bit longer than expected. In times of inflation and negative real interest rates, equities have almost never given a negative return in the past, according to JP Morgan’s outlook with chief strategist Vincent Juvyns (photo).
Before Juvyns gave his outlook, he looked back at how his predictions of last year performed. He called this a test of modesty. He was right about the economy and shares, but he was wrong about a few other things. Growth did better than value whereas we had previously counted on value to make up the difference.
“China was one of the laggards given all the problems there have been in recent months and we did not predict that. However, the long-term story of China remains intact. In contrast, we were comfortable with Chinese government bonds, which posted a 15% return in euro terms in an environment where most government bonds have performed negatively. We also tipped the scales on a weaker dollar. However, the currency has remained quite strong and we expect the greenback to remain strong in 2022.”
Inflation but no stagflation
Juvyns said he expects inflation to normalise by the end of 2022. “That is a bit further in time than we had hoped for by mid-2021. Nevertheless, we are starting to see a reduction in supply-side bottlenecks, while container costs are finally falling. On the other hand, labour cost inflation could stick around a bit more. In many places, there are more vacancies than unemployed people. And the tension in the job market is one of the reasons to raise inflation expectations for the next 5 to 10 years. And so is ESG, because the mandatory change in the energy mix to more renewable energy will increase costs. We are already seeing prices for CO2 emission rights going through the roof.”
However, according to Juvyns, there is no stagflation in the offing. “There may be higher inflation, but there will also be growth. The global economy should grow by 4 to 4.5 percent in 2022, above trend. Consumers will continue to support growth, especially given the surplus savings deposits that have built up in recent years. In addition, investments by the private and public sectors are also supportive.” He also stated that company balance sheets have never been stronger. “Investments can be made and are necessary, especially to bring production facilities closer to home. And those higher investments will boost productivity and dampen the negative demographic impact.”
Interest rates
JP Morgan AM pointed out that it is a good time to borrow money because one can do so today at negative real interest rates. “It will be a bad year for savers, for cash and fixed-income investments. And the investor will have to take more risks than ever.” Juvyns added that real returns in most markets will be negative in the long term.
Central banks cannot allow interest rates to rise too fast, as this would wring the necks of governments. He said. he reckons monetary policy will normalise everywhere except in China, but that this may be slower than markets are currently pricing in. “We believe the Federal Reserve will make two interest rate hikes in 2022, in June and September. And by June QE in the US should be done. At the same time, the budget deficit will improve so that the government has to issue less. This will prevent interest rates from rising too much. At the end of 2022, we also expect positive interest rates in Germany and Europe.” On the bond front, Juvyns is now mainly looking at high yield, as the default rate after a recession has never been so low, and at Chinese paper. “The yield is high, it offers high diversification and the central bank is more likely to cut interest rates.”
Equity markets
Juvyns emphasised that in times of inflation and negative real interest rates, equities have almost never given negative returns in the past. “We are therefore still very positive for equities, even though earnings growth will normalise in 2022. Costs for companies will rise but there is no longer a taboo on raising prices: margins will remain strong. In other words, equities are a good inflation hedge. Valuations are quite high but are slightly lower than at the beginning of 2021 thanks to strong earnings growth.”
The strategist concluded that the S&P has a potential of 5 to 6 per cent if earnings growth reaches 8 per cent. He also identified China as one of his favourite markets and expects dividends and share buybacks to become more important again. “Given the expected rise in interest rates, we are leaning more towards value in the US. So we see dividend stocks outperforming. Quality and cyclical sectors are also our preference. Finally, JP Morgan AM will continue to invest in the structural theme of energy transition. However, it is more difficult than simply buying clean energy and selling old energy sector. The latter sector is today priced at the worst possible scenario and has a place in the portfolio anyway. We also believe that the clean energy sector in China is significantly undervalued.”
Extra steps for above-average returns
JP Morgan AM has calculated an annualised return of 2.8% for a 60/40 passive portfolio investor in euros over the next 10 to 15 years. “That is rather disappointing and is in sharp contrast to what we have seen over the past 10 years, which is an annual return of 6 percent.” That 60/40 split will be insufficient so asset managers have a lot of work to do to close that gap of more than 3 per cent, the financial group said.
However, there are several ways to provide that extra return, said the asset manager. “First, in a low return environment, active management can make the difference through tactical asset allocation and stock selection. Financial markets vary widely in their record average valuations and there are many opportunities to generate alpha with some research.”
Secondly, the selection of the best-scoring ESG companies can provide additional returns. The top 20 percent of ESG companies generate on average 2.5 percent alpha per year compared to the index. Higher ESG-scoring companies are more profitable and less volatile. We try to identify these ESG winners via our own scoring system. Thirdly, extra alpha can be found in alternatives such as private equity, private debt, hedge funds and real assets. Finally, diversification is also important. For example, China is becoming increasingly important.”