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January 13, 2022

2022 Outlook: Into the Omi-Verse – Wash, Rinse, Repeat

We are entering 2022 much the way we did 2021, riding an accelerating global wave of COVID-19 infections. A year ago, there was widespread optimism that the imminent rollout of vaccines would unleash the reopening of locked down economies, supported by ongoing massive fiscal and monetary policy. In broad strokes, that is close to what unfolded with some clear curve balls along the way – the two biggest being the Delta and Omicron variants and the spike of inflation to multi-decade highs.

 

While the 2021 economic reopening boom was significantly dampened over the summer by the emergence of the Delta variant, it proved to be more a case of demand deferral rather than demand destruction. The economy reaccelerated rapidly in the fourth quarter of 2021, as cases subsided and evidence piled up regarding the high efficacy of vaccines in preventing worst-case outcomes. For a brief time, it looked like our 2021 post-pandemic reopening boom narrative was back on track. The impact of Delta was to slowdown and extend the recovery over a longer time frame – two steps forward, one step back. For investors, an extended period of slower but still well-above trend growth versus the original envisioned boom bust was ironically a more desirable outcome.

 

Into the Omi-Verse

 

As the end of 2021 approached, along came Omicron. Today, we enter 2022 with the global economy,  particularly the U.S. economy, under a full head of steam crashing into a tsunami of Omicron. With an off-the-chart level of transmissibility, the world is awash in Omicron and healthcare systems are on the brink of overwhelm with escalating cases and rising infections in front-line workers. Targeted lockdowns and further constraints will continue to arise throughout January as we weather this latest wave. On a positive note, while highly infectious, Omicron appears far less severe for those infected, particularly in those who are vaccinated. While the next month will be severe due to sheer numbers, it may place us one major step closer to reaching endemic status, enabling us to normalize behaviours as we learn to live with the virus, much as we do with the flu. Although it is too early to be definitive on this prognosis, we continue to remain optimistic.

 

Wash, Rinse, Repeat

 

If so, we expect that following the post-holiday surge, cases should peak in coming weeks as it was during the Delta wave. We do anticipate some softer economic data over the December 2021 to February 2022 time frame, but this will again be more about demand deferral versus demand destruction. If there is a slowdown, we would expect to see another mini reacceleration into the spring as the stop-go-stop-go reopening recovery continues through 2022.

 

U.S. Leads the World

 

For 2022, we expect another year of robust global growth led by the United States. U.S. GDP growth will likely slow from an expected 5% to 6% pace in 2021 to a ballpark range of 4% in 2022 as the recovery matures. However, keep in mind 4% still represents one of the fasted growth rates in recent years and is about two times the trend of potential growth.

 

Do Not Bet Against the U.S. Consumer

 

Growth will be driven by the U.S. consumer who still has significant pent-up demand potential, particularly in the services areas. In aggregate, U.S. household balance sheets are in unusually fantastic shape as they exit a recession. The unprecedented nature of the COVID-related fiscal transfers in the neighbourhood of $5 trillion or 25% of GDP bolstered household savings by roughly $2 trillion. In addition, the broad strength in housing and asset markets has increased estimated household net worth by over $20 trillion or 100% of GDP. This broad-based rise in savings and wealth across the spectrum of U.S. households leaves them well-positioned to support consumption spending in the coming years. There are two other factors likely to support above-trend consumption. First are the early signs of re-leveraging through increases in revolving credit and bank lending. Having de-levered during the pandemic, there is significant room to support a new leverage cycle. Second is the strength of the housing market. In the U.S., the housing market collapsed during the 2008 crisis and essentially stagnated for most of the decade. Now it is back! Unlike in Canada, where housing has remained robust throughout the last decade, the U.S. is arguably closer to the start of a housing cycle. This remains a key fundamental area to monitor as the multipliers from housing into the broader economy are significant. If the U.S. is going to break out of the slow-growth secular stagnation slump of the post-2008 era, it will require housing to remain in a strong secular growth phase in coming years. This will also be a key factor influencing the inflation trajectory, particularly through employment and wage growth, as housing is a very labour-intensive part of the economy.

 

Consumption will not be the only driving force for growth. Inventory restocking will be a cyclical driver as companies continue to play catchup to recent supply-demand imbalances. At the same time, we expect to see a ramp in corporate capex as record earnings, easy financial conditions, years of lackluster capex, accelerating industry trends and new green investment opportunities all remain tailwinds for strong corporate spend.

 

Economy Rips – Policy Taps Turn Off

 

A year ago, it was all about maximum fiscal and monetary policy support, pushing hard to drive growth. 2022 will be the opposite and focus on the private sector economy being unleashed as policy support is withdrawn. Dialing back counter-cyclical fiscal and monetary stimulus as the economy ramps up is both appropriate and unlikely to derail the recovery. But as in any period of transition, it can and will generate significant cross-currents for investors to navigate.

 

Adieu Fiscal Stimulus

 

Perhaps the easiest to deconstruct will be the wind down of fiscal stimulus as it is a more direct drive into the real economy. Offsetting some of the strong private sector demand will be a contraction in fiscal policy spending as the extreme fiscal spending programs of the past few years are now over. Most of the $5 trillion+ fiscal spending of the past two years was aimed at income replacement related to pandemic shutdowns and has now expired. With gridlock expected to return to Washington with the 2022 midterms, fears of unconstrained fiscal expenditures are exaggerated. Though, the benefits from this spending will continue to be felt for years to come as indicated by the boost to household savings and net worth that these programs enabled. As employment income continues to replace government transfers through 2022, fears of a “fiscal cliff” economic slowdown are misplaced. This is a much-desired hand-off back to the private sector.

 

U.S. Fed Pivot

 

For investors, the more complex issue pertains to the now commenced process of monetary stimulus withdrawal. With clear evidence of building economic momentum and the persistence of decade-high inflation prints, the U.S. Federal Reserve (the “Fed”) made a definitive pivot toward a more hawkish stance in December 2021. As it stands now, the Fed has accelerated the tapering of quantitative easing with an expected completion by March 2022. In doing so, they have brought forward the optionality on commencing interest rate hikes off the zero bound to as early as March, with current market expectations of three rate increases this year. The exact timing and pace will ultimately be very data dependent, particularly with respect to inflation data. This pivot has shifted the Fed’s reaction function back into an inflation-first approach for now, abandoning its recently adopted “let it run hot” approach from August 2020. This is a material shift in the monetary policy regime for 2022. From a fundamental economic perspective, a change in monetary policy driven by the underlying strength in demand is not a bad thing. In fact, with rates starting at zero, the economy growing at close to twice its potential and unemployment falling back to sub-4% levels, it is easy to argue that the Fed is behind the curve and rates should already be higher than they are today. However, given the nature of the current pandemic and policy-driven cycle, that would be a bit harsh. From my perspective, I would not characterize the current pivot as a Fed error. Instead, I view it as a reaction to the unfolding nature of the cycle that recognizes there is no need to be adding stimulus, especially with the rapid pace of economic recovery. Like a supertanker, monetary policy takes time to turn.

 

The result, for investors, will involve shifting tides and cross-currents in financial markets but from a point of very easy and supportive financial conditions. The longer-term concern around monetary tightening is when rates reach a level that they begin to choke off economic growth, risk tipping the economy toward a recession. A Fed error would be when they tighten too far or too fast. For most cycles, it is not the first rate hikes that are a concern but rather the last couple of hikes when they go too far. Pencil in 2023 and 2024 as a more likely time to worry about interest rate hikes being problematic for the economy.

 

Inflation is Tricky

 

There is a chance that persistent inflationary pressures may force a more rapid acceleration in the pace of tightening, but that is not our base case today. While current inflation prints are extremely elevated, there is a significant component that is driven by transitory and base effects that will unwind over coming quarters. Along with the expected deceleration in demand growth, also from elevated levels, it sets the stage for the Fed to be embarking on a tightening cycle at a time when both inflation and growth will be falling – a tricky dance to navigate when the incoming data is far noisier than usual. This will not deter the commencement of tightening but highlights how important it will be to monitor both the underlying data and how the Fed responds. The narrative around the inflation data and outlook will be in flux in the coming years, just as it has this year. Policymakers and markets will continue to adjust as the data unfolds. Attempting to forecast the ultimate trajectory of inflation in the current environment with any degree of accuracy is pretty much impossible. That is why our approach for 2022 is to stay on top of the unfolding data and policy dynamics, while understanding their potential implications for economies and markets as they evolve.

 

Major Risks

 

For 2022, I would highlight two key areas of risk for markets. The first would be the path of inflation and the monetary policy response. For markets, this risk can unfold in two ways. One would be if inflation does embark on a sustained increase above of ~3% and forcing the Fed to continue tightening policy sufficiently to curtail demand and ease inflationary pressures. This would not be a Fed error; it would be a recession outcome aimed at curtailing inflation. It would be completely aligned with the Fed’s legal inflation fighting mandate but would be a disaster for risky assets. The other risk related to inflation would be a Fed error, where they pivot too hawkish in reacting to what is ultimately only a transitory overshoot of inflation. Should policy be whipsawed by a misreading of the inflation trajectory, it would also drive a sell-off in risky assets but could be shorter-lived should the Fed reverse course. Either way, inflation and Fed policy will remain top of mind for investors in 2022.

 

The second major risk bucket is more exogenous to the economic cycle but needs to be watched. That is what I’ve referred to as the ongoing “geopolitical recession” – a term borrowed from Ian Bremmer at Eurasia Group. The post-WWII global order continues to crumble before our eyes. From a geopolitical perspective, the world is inherently more fragile and risk-prone than any other time in our careers. While markets are generally driven by economic and not political trends, it is important to understand when and how geopolitical risks might tip into the economic and market realm.

 

Today, there are several broad areas of tension that must be on our radar as having potential market implications. While there is not the room to delve into them here, they are worth mentioning and include:

  • U.S. domestic politics and polarization
  • China
  • Russia
  • Iran
  • Other emerging markets

 

Markets and Positioning

 

Overall, we expect 2022 to be a good (not great) year for equity markets supported by still favourable earnings growth, while bonds continue to lag in the face of rising rates. In the U.S., with both GDP growth and inflation above trend, we see strong nominal GDP growth in the 7% range. This will be a very favourable backdrop for earnings, which are driven by nominal rather than real growth. As in 2021, I expect earnings to continue to beat current estimates and expect 10%+ growth in 2022. For the S&P 500, EPS should reach 230 in 2022 and 250+ for 2023. Last September, I suggested that 5,000 on the S&P 500 made sense by the end of 2022, and with earnings continuing to beat expectations, that target is achievable with even a little upside toward 5,200. However, with the S&P 500 ending 2021 at 4,766, that only leaves an expected 5% to 10% upside for 2022. While this is good and not great, it is certainly the best expected return amongst major asset classes. Along with an expected modest return for equities, we also expect a much bumpier ride as shifting monetary policy impacts market liquidity. 2022 is a year for cautious optimism and tactical opportunities. This is not the stage of the cycle for all-in optimism, but nor is it time to be fearful.

 

Within our CI Global Income and Growth Fund, we moved our equities exposure to neutral from overweight at the end of 2021, and remain underweight government bonds and overweight cash. The rise in cash in December came from taking equities down to a neutral 60% weight as uncertainties around the rise in Omicron, equities at record highs and the Fed’s policy pivot were all cause for increased caution in the near term. We expect to have opportunities to selectively redeploy back into equities in the coming months.

About the Author

Drummond Brodeur


Drummond Brodeur, CFA

Senior Vice-President and Global Strategist
CI Global Asset Management

Drummond Brodeur, is Senior Vice-President and Global Strategist at Signature Global Asset Management. Mr. Brodeur has been in the investment industry since 1989. He has a strong background focused on China and the Pacific Basin. Prior to joining Signature in 2007, he oversaw international portfolios as Vice-President, Investments, at KBSH Capital Management Ltd. Previously, he was a senior analyst of Asian equities with the Caisse de Depot and Portfolio Manager, Asian Equities at Bankers Trust Australia. Mr. Brodeur holds a BA from the University of Western Ontario, an MA and MBA from Monash University, Melbourne, Australia, and the Chartered Financial Analyst designation.

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Publication date January 11, 2022