FOUR key themes will set the tone for 2022 in financial markets – inflation, interest rates, corporate earnings and valuations. No-one should expect a repeat of 2021, which was a lot kinder to investors than anyone could have predicted 12 months ago. But there’s good reason to hope for another positive return this year.
Rising prices are the enemy of investment returns. They eat into the real value of your money and even at a relatively modest rate the impact can be devastating. Remember, a 4% inflation rate halves the purchasing power of your savings and income in less than 20 years. So, the current 7% rate of price growth in America, and not far behind that here in the UK and across Europe is the first cause for concern. Central banks no longer talk about ‘transitory’ inflation, but the hope remains that the peak could be reached by mid-year.
How central banks deal with those rising prices is crucial. The Fed has made it clear that it will stop buying bonds by the spring. That will open the door to higher interest rates. The financial markets are sceptical that it can do this at the pace it hopes and a slower and lower trajectory for interest rates will certainly help keep the market on track. Modest tightening and a turn in the inflation cycle will be easier for shares to take in their stride than bonds, however. Expect another tough year for fixed income.
Last year built on the recovery from the early pandemic recession in 2020. Throughout 2021 earnings consistently came through more strongly than analysts had predicted. Inevitably those double digit rises in company profits won’t be sustained this year. More likely is a growth rate in the high single digits. While this represents a slowdown, it would be more than acceptable and has the potential to keep investors interested in shares, especially if bonds continue to look relatively unattractive. The key question then will be the price that investors are prepared to pay for a share of those profits.
And this is where the direction of valuations becomes so important. Last year, the multiple of earnings at which shares changed hands declined modestly as investors started to look through the recovery to a more subdued earnings outlook in the years ahead. That’s normal because stock markets are always ahead of the reality on the ground. At just over 20 times expected earnings, the US market is expensive by historic standards but not excessively so. Elsewhere in the world, multiples are less demanding, and materially so in the case of the out of favour UK market where the FTSE 100 trades on around 13 times earnings.
So, as ever, there are pros and cons, things to worry about and reasons to be optimistic about your investments. We wish you all a happy and prosperous 2022.