Jeff Lewis, director of Edinburgh IFA, RobMac has been expertly summarising the financial news for a number of years. Here’s his first for 2022.
While the Omicron variant appears to be on the decline in the UK, it is still continuing to run rampant in some of the world’s big economies. The obvious questions to ask are: will Omicron turn out to be as bad as some feared; will it put a spanner in the works of a global economic recovery; and could it destabilise markets?
It appears that financial markets believe we will shake off the Omicron variant. If we look at the evolution of consensus forecasts for economic growth this year over the last few months, it shows us some interesting things.
Last year, the expectation was that the UK would grow very strongly this year, with good growth in the US and EU as well. And, although the outlook has dimmed a little, there hasn’t really been a significant change to forecasts since the arrival of Omicron, which has really affected northern Europe the most.
Likewise, if we look at forecasts for what will happen to inflation during the year, we can see that the expectation is for a very significant increase in the UK, a reasonable rise in the US and, actually, for a period of remarkable stability in Europe. Hopefully by the middle of the year this will begin to dissipate in all three geographical areas , it wasn’t too long ago we were all worried about deflation .
In terms of Omicron specifically, we know that it is much more transmissible, but much less severe, and has been disproportionally hitting younger age groups. Importantly, the forthcoming introduction of anti-viral pills will offer significantly higher protection for the vulnerable. In short, the world is much better protected against the virus and its variants, whose impact should continue to diminish during the months ahead.
Another pressure on economic activity has been supply shortages. According to the purchasing managers’ indices (PMIs), manufacturing in Asia excluding China has had a big bounce, moving back into positive territory. Similarly, the production of semiconductors in Korea has jumped. The shortage of semiconductors has been a big problem for the automotive sector, but as it continues to clear there should be a healthy increase in production to come.
Turning to some of the other forces at work, on the plus side, US consumers have huge spending power, because of what some managers’ have called the ‘Covid piggy bank’, or the savings they’ve built up during lockdowns and as a result of government stimulus. Consumer spending is set to remain strong in 2022 which will help the global economy continue its bounceback .
American companies are also increasing their capital expenditure, which is good news for demand, profitability and productivity. This is happening because companies have plenty of cash, their margins are high and there is a labour shortage. This is a positive both for the economy and the stock market.
Supply shortages are also easing in the US, in part because of the semiconductor effect mentioned earlier, but also because the surges in demand that take place on Black Friday and at Christmas have passed.
Prices have also been rising in the US, notably of used cars, which have doubled in the past year or so. Car rental prices have come down but remain high. Both of these have been driven by the shortage in supply of new vehicles.
Even as that bottleneck eases, however, there may still be pressure on the labour market where, despite employment remaining well below pre-covid levels, there is still a big labour shortage. This in turn is feeding into wage inflation. The rising cost of renting accommodation in the US is also a major factor contributing to inflationary pressure.
Bring all of these effects together, and we expect that overall inflation will continue to rise over the next few months but then begin to ease . In the meantime its likely interest rates will rise towards a new normal of perhaps 2% by the end of 2023.
Finally, there is corporate earnings, which are driven by the economy. Analysts’ earnings forecasts expect to be upgraded as they were last year which ought to lead to the values of companies rising and therefore equity markets too . Perhaps a 5 to 10% return on equity is a possibility .
Drawing all of these various moving parts together, it seems clear that medical science is enabling the world to ‘live with Covid’. Major central banks are continuing to tighten fiscal policy, but the underlying financial conditions remain highly supportive. Companies have plenty of cash and are not struggling with debts, and the financial firepower of consumers also remains strong.
So, if corporate earnings are going to outperform, we think that equities will continue to rally and, as last year, will again generate better returns than lower risk assets therefore you will be rewarded for continuing to take a calculated risk .
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