When we look back at 2021, one may well consider it challenging even though the S&P 500 notched a total of 70 record highs over the year. For a second calendar year, Covid-19 created volatility in financial markets with two major macro themes, which wavered throughout the year with varying enthusiasm: inflation and commodities price boom. Market participants' appetite for stocks meant that cash investments into equity funds in 2021 surpassed those of the past two decades combined.
For 2022 we have a preference for equities over government bonds and credit. Given the inflationary environment, the interest rate path has been shallower than in previous tightening cycles, supporting our overweight to inflation-linked bonds. The low interest rate environment supports an Equity overweight with a focus on Developed Markets and the U.S. in particular.
In comparison to other assets, Equity valuations remain reasonable from a cash flow generation perspective. Valuations are also supported by strong secular tailwinds (strong excess liquidity, balanced relative valuations, and continued strong corporate free cash flow generation), as well as, from a tactical standpoint, strong pent-up demand and low inventories.
We balance our equity exposure with some bond duration but prefer inflation-linked bonds over nominal government bonds. This is because we see inflation persisting and nominal yields rising more than real yields.
We are often asked whether inflation and the risk in real yields can derail stocks in 2022. We believe not: while even if real yields rise but from extremely complacent levels (i.e. -1%) to still accommodative levels of about -0.25%. Real yields will likely gradually revert to positive territory in the coming years and at a pace that risk assets should be able to handle and remain far from levels that can start challenging economic expansion.
We think that the economy in 2022 will be defined by a full global recovery and an end of the global pandemic which we believe will produce a strong recovery, a return of global mobility, and a release of pent-up demand from consumers (e.g. travel, services) and corporates (inventory, CapEx and buyback recovery).
Please follow the link to access our full 2022 outlook.
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