It’s the time of year for reflection and looking ahead, a short twelve months since I wrote in a similar vein.
Since my last message we have received worrying news of a new variant ‘Omicron’. We continue to be prudent in how we interact with our clients. We have had a very recent case of Covid within our administration team (with severe symptoms despite a double jab) which has proved upsetting and worrying so we will continue to be cautious in our interactions.
The bulk of this missive contains Ben’s view on markets, but as usual I would like to preface it by thanking all of you for your continued forbearance as the challenges of Covid continue, albeit in somewhat different form. Similarly, I’d also like to (again) put on record my thanks to our wonderful staff who have continued to offer a first-class service to our clients either in the office or from their homes. Sadly, we have postponed our ‘Secret Santa’ ceremony until the new year when we hope to all be well and can convene in the office, rules permitting.
Investment Director Ben Yearsley’s 2021 review and Outlook for 2022
It is possibly wrong to say this, but we do live in fascinating times; covid, inflation, central bank policy mis-steps, politics, the list could go on.
This time last year I was broadly positive as the first covid vaccine had just been administered and the rollout of those vaccines (discovered and approved in record time) was clearly going to have a massive impact on markets in 2021. That proved to be the case. In fact, according to Our World in Data, 8.47 billion doses of vaccine have been administered in little over a year. The problem currently is that vaccination rates in low-income countries is poor, leading to new variants such as Omicron. By the way, I wonder why the WHO skipped the letter Xi when naming the latest variant… (hashtag smiley face..). Markets have been quite sanguine about variants evading vaccines – surprisingly, that is still the case despite Omicron data suggesting three jabs not two are needed. Maybe markets just accept that covid is here to stay and that companies and countries will adapt.
2021 has been a good year. In local currency terms the S&P 500 is the standout (again) of the major markets. In fact, most western developed markets have had a good year. Asia has been the moribund area with Hong Kong down, China flat to down and Japan scraping a low double digit return (TOPIX is currently up 11% YTD). India on the other hand has had a stellar year with MSCI India gaining 29% so far. It is easy to forget how badly the covid crisis hit India in the Spring, yet now 800 million doses of vaccine have been administered.
Government bond markets have been volatile. The ten-year UK Gilt started the year with a yield of 0.2% and currently yields 0.83%. In October it hit a yield of 1.15%. The US market has acted similarly with the ten-year US Treasury starting at 0.92% before hitting over 1.7% a few times and currently stands at 1.48%. Diversifier? Yes. Safe asset? Well, it depends on what you mean by safe. From a real return perspective, considering inflation, government bonds sit on a large negative yield currently. Of course, those investors who bought government bonds at the start of 2021 are now sitting on losses except those who bought into inflation linked bonds.
China’s regulatory crackdown was one of the more interesting non covid stories of 2021. It caught many by surprise and the share prices of the big internet stocks are still down. I’m not sure who was investing in China though who didn’t consider regulatory risk and politics a threat? Experts appear split on whether China is a buying opportunity or not. For what it’s worth, I think it is.
From an economic perspective most countries have recovered most, if not all, of the losses due to covid. V shaped recoveries have been commonplace, as was predicted by many. The UK has had a V recovery (as can be seen in the chart below), however the rebound slowed over the summer during the “pingdemic,” and Omicron will dent it further. Notwithstanding that, the global recovery has been impressive.
This time last year I said there were three things to watch for in 2021: vaccine rollout, Biden’s policies, and inflation. Two of those have been important; vaccine rollout and inflation. President Biden’s policies have been irrelevant to markets, though might have more of an impact in the future especially his infrastructure bill.
The vaccine rollout affected how quickly countries bounced back economically – the UK was astonishingly good at getting jabs into arms in the first half of 2021 and stole a march on many developed nations. This meant the UK was faster out of the block, however it also meant that vaccine efficacy waned sooner than other countries leading to a summer slowdown. However, because the UK’s autumn booster jab programme started sooner than other countries, out of necessity, the Omicron wave might be lighter. Over time though, countries will even out. Inflation was the most interesting of the three things to watch for in 2021 – I’m sure some of those predicting transitory inflation (me included) have been caught out by the stickiness.
My FTSE 100 prediction for 2021 was to finish the year at 7500. When I started preparing this, I was about 350 points away and I felt there was a ‘Santa rally’ coming to get me close to my target and then Omicron struck. So, another miss, but hey I always treat any FTSE prediction with a large dose of salt!
Three things to watch for in 2022
Inflation, M&A, and the decarbonisation and electrification trend. Inflation has been rampant for months, yet central bankers are happy to sit on the side-lines and leave rates where they are. They are taking an almighty gamble on transitory inflation as the longer this persistently high inflation continues the more likely it will feed through to wage inflation causing much stickier inflation. It feels like a policy error is now on the cards.
Takeovers and M&A, especially in the UK, have been one of the dominant themes in 2021. $3.4 trillion of deals have been transacted globally so far (according to Pitchbook). With money still cheap, even with a couple of rate hikes priced in, and the attraction of alternative investments for investors (private equity for example) this theme will continue. The UK seems particularly vulnerable to M&A due to a combination of cheap prices, dividend and high free cash flow culture and a relaxed attitude to takeovers. What has been missing is a mega money takeover in the UK to really ignite the market.
Finally, decarbonisation and electrification will be the dominant theme of the coming decade. According to Schroders, annual clean energy capex stands at $320 billion – it needs to be $850 billion to hit 2050 net zero targets. Another way of looking at it is to say that we need to quintuple solar energy generation (and other forms of clean energy generation) by 2030 from 1000 GW of installed capacity today to 5000 GW to reach 2050 targets according to the IEA. Valuations are high in many areas, but this trend isn’t going away.
The same comment could have been written here for the last 4-5 years: the US is expensive. In the short term there probably isn’t anything to knock the US market significantly, however with growth stocks on the “never never” even small interest rate rises have the ability to take the froth off the top. It feels as if the US has most to lose from rate hikes, whereas the likes of the UK with a big financial services sector will be more insulated. Having said that it also feels that we are still in a bull market and the US is likely to continue rising. Looking forward is more interesting than looking back though and there are some different trends at play that (in my view) means the US won’t be the stock market of choice for the next decade despite many of their companies remaining globally dominant.
It feels as if Asia has been treading water in 2021, with many markets not benefitting from a covid recovery bounce (with some notable exceptions such as India and Vietnam) and you’ve also had China’s regulatory crackdown impacting sentiment. Valuations are also reasonable in many markets, which is why Asia is the region to watch for 2022.
Tech and the internet giants have been the clear winners of the last 5-10 years and although technology is now embedded in everyday life that doesn’t necessarily mean these same companies will lead stock markets. It feels as if the new multi decade trend will be decarbonisation and electrification and the current leaders in this space aren’t found in the US. The problem is, and like tech, it is such a hot area (global warming pun intended) that valuations in many sectors are sky high, however the sheer amount of money needed to decarbonise the planet gives a huge long term growth trajectory.
The UK markets
I think the UK market, on a relative basis, still looks decent value. Profits and dividends rebounded nicely in 2021. However, it is M&A that is possibly the thing to watch for next year. 2021 has been one of the most active on record for takeovers of UK listed businesses. Private equity and other overseas companies clearly see value in UK plc. The one thing that has been missing this year has been a big headline grabbing takeover. Will 2022 see the likes of BT, Sainsbury, or M&S fall? They are the three that get talked about the most, however could a leftfield takeover occur. Vodafone maybe or even the life companies that trade on low multiples and have high free cash flow. Returning to the theme of profitability and dividends, there is still some post-covid catch up going on so the outlook for next year should be good – special dividends are in vogue and the likes of Aviva will be paying large ones. You also have the oil sector generating huge levels of free cash flow, a large part of which will be returned via dividends (and buybacks).
I’m optimistic for Sterling. Assuming no more covid variants derailing things, rate rises are surely on the cards for 2022. At the same time, the UK’s post covid recovery continues nicely and there will be some catch up from the fourth quarter slow down. The pound might be slightly range bound but I don’t see any reason for weakening. Of course, any sterling strength will prove a headwind for the FTSE and overseas investments, but an overall positive equity outlook should outweigh a sterling brake.
Hmmmm. Hmmmmmm. At the risk of repeating myself from last year’s comment, the outlook for bonds is unexciting. However as has been seen several times this year, core government bonds, and some high quality corporate bonds, do provide good diversification benefits in times of stress and turmoil and there is no reason this won’t continue. The reason the outlook is unexciting is if we have seen the last big covid variant then what exogenous shock will cause a flight to quality, i.e. government bonds? If you then add in potential interest rates rises, why would you buy these same bonds? There is value in high yield and emerging market; both areas will benefit from the continuing recovery in global economies.
UK residential property has been on a long term bull run and doesn’t show many signs of slowing down. One of the big problems in residential (and seen in the depressed price of online agents PurpleBricks) is lack of supply, exacerbated by covid and staycations. However, from an investment standpoint, it’s commercial property most will focus on. The outlook for that is mixed. Offices and retail will remain under pressure, especially if covid restrictions remain in place globally. However, with offices the gloom seems overdone. We might not need as many offices in the future, but they will still remain integral – in fact, there is an argument that companies will need as much space as currently, even if working from home part of the week is the norm in future. Retail is much harder to call – internet sales have boomed during the pandemic and it’s hard to see that trend reversing. On the positive side of property, anything related to internet, home deliveries, data centres, and other similar areas is in huge demand. Overall, property will see muted returns in 2022 however it is more nuanced with pockets of excellence and buckets of gloom.
One of the most popular areas of 2021, especially new launch, and top ups to investment trusts. Many of those trusts have been renewable energy related, however that doesn’t take away from their general popularity. The definition of infrastructure has widened, partly as economies have digitised, but in general it is assets essential to everyday life. This now includes assets such as data centres and mobile phone towers, but also gas and water pipelines and renewable energy projects. I’ve been proponent of infrastructure for many years, I see no reason to sell out. Yes, sometimes it’s boring, but it’s often boringly consistent. With many underlying assets benefitting from inflation linked income streams it is one asset class that should cope well in an era of higher inflation.
It feels like the wrong environment for gold. Yes, there is high inflation, or high relative to recent times, but it is probably transitory and although gold should be a good inflation hedge over the long term, over the short term it’s the direction of real interest rates. Once through the Omicron variant issues, it is likely central banks will up rates making the outlook for gold unexciting.
2022 FTSE prediction
So last year I said that the FTSE would end 2021 at 7500: until Omicron I was on course to at least get close and to be honest I’ll take a 2-3% miss! I am going to suggest a figure of 8000 for the end of 2022 on the basis that UK profits are looking good (and profit growth should continue into next year), buybacks will remain strong, and that the energy crisis with the knock-on impact on inflation and cost of living will abate. As ever though take any FTSE prediction with a large pinch of salt.
Have a safe Christmas, and please continue to look after yourselves. As usual, we will close our offices on Christmas Eve and not return until the first Tuesday in January 2022 (4th). Please contact your adviser if you need us, or me on 07539 002012.
My best wishes to you all,
Jon Treharne MD