Introduction
The Quantitative Easing (QE) cycle that began following the Covid pandemic has been truly unprecedented.
Between March 2020 and February 2021, in a matter of only 11 months, many high flying growth stocks have quadrupled or grown by multiples, especially those that had benefited from the Covid-19 digitalisation acceleration process.
Since February 2021, apart from the likes of big Tech companies like Apple, Amazon, Microsoft and Google, many have declined by 50-75%! Just as how quickly these high growth stocks have expanded, so too have their contraction been over the past few weeks especially.
It is sufficient to say that due to Covid and the magnitude of the QE, animal spirits truly came into play, with moves exaggerated in both directions.
So what we have effectively seen, is that the past 20 months had been ‘borrowed from the future’ only for some of these crazy returns (stretched valuations) to be given back.
Are future returns likely to disappoint?
Let’s begin by going through some of the key risks we see happening in 2022!
Key Risks #1: GeoPolitical Tension
The world wants, and is already trying to put Covid behind us. What has been clear in the past few years, and especially since the world stage was forced to close borders and issue lockdowns due to Covid, is how the US-China relationship has continued to falter.
It is also increasingly clear how both great powers have embarked to decouple away from each other. For example, China is still adopting a Covid zero strategy while USA and Europe are trying to live with Covid.
Apart from this, we have seen how China and the USA are both trying to win the tech race, especially in Artificial Intelligence (AI) and Quantum Computing. Tension is already brewing with Washington placing a dozen Chinese companies on an export blacklist.
Furthermore, China is increasing her military might as reflected in an increase in defence spending of 6.8% compared to 2020, and also concerns have been raised in Western media about China testing hypersonic weapons.
Key Risk #1:
As the world starts to look past Covid, US-China rivalry and tension may once again start to take centre stage as it did in 2018.
It is often in conventional political playbooks, to find external sources of issues to focus the public’s attention away from domestic woes.
Both China and US political leaders may begin to play up these tunes in 2022, and if it does materialise, it will likely have a negative impact on the global equities market.
Key Risks #2: Inflation Panic
In our numerous prior AlgoMerchant articles, we have highlighted how 2021 will be a year where high inflation may hit new headlines, and true enough did it actually materialise!
In our latest inflation article, we further highlighted to our community readers that markets may have already priced in peak inflation, which is why the US S&P 500 still remains strong despite numerous inflation scares.
Therefore the way to think about inflation in 2022, is perhaps slightly different from 2021. In 2021, it has been a tug of war about whether inflation was going to be high or not. In 2022 it is materially different. Inflation is already high, therefore the narrative going forward is actually whether the Fed is going to start to panic about inflation!
Throughout 2021 until almost the very end, the Fed Chairman Jerome Powell fed the financial markets with the narrative of ‘transitory inflation’. However, towards the end of the year, he started to pivot away from that notion, by recognising that higher prices could remain sticky.
By changing tack, he is setting a stage whereby if indeed the Fed had moved too slowly in 2021 to tackle inflation, 2022 will be the year they may aggressively move to tame inflation which has resulted in unsustainable consumer prices that have eaten up wage increases, and both consumers’ and enterprises’ discretionary income.
Key Risk #2:
The reward/risk ratio for equities will likely diminish in 2022.
This logic is founded on the basis that the Fed has already communicated a path to tapering and also increasing interest rates for the first time in several years in 2022.
The risk comes in, if and when the Fed starts to taper and increase rates in 2022, more aggressively than expected.
Should this happen, popular growth stocks may continue to slide, but more importantly the S&P 500 which has so far relied on growth stocks for most of its gain in the past 12 years!
Key Risks #3: US Politics in Focus
The stakes in US politics have never been higher. In recent years, the ideological gulf between the Democrats and Republicans have widened. The fact and evidence has shown that middle ground solutions and bipartisan approved bills are diminishing in count.
Financial markets have been looking forward to Biden’s Build Back Better Act which has an estimated price tag of $1.75 trillion. However, Joe Machin, the sole Democrat, who the Democratic Party so desperately needed his buy-in to seal the deal, has thus far refused to provide his endorsement.
Looking at 2022, there are fewer upside narratives when it comes to high value fiscal policies.
Here are some gruelling events that may send the US stock market down, if not handled properly by the folks in Washington D.C:
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Markets may also start to soften heading into the early November mid-term elections
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Finally, lawmakers may also have to tussle over another debt ceiling debate near the end of 2022.
Key Risk #3:
The reward/risk ratio for equities will likely diminish in 2022 from the perspective of US fiscal policies.
The last high value Act (Build Back Better) is not likely to be passed due to a sole Democrat’s disapproval.
This means there is no further upside narrative by way of stock rallying due to fiscal stimulus.
On the other spectrum, there are numerous gruelling fiscal events that if not handled properly in 2022, may result in a softer equities market.
Key Risks #4: If..a deadly Covid Variant emerges
Both Delta and Omicron did little damage to the stock market because they both did not materially affect the narrative that these 2021 strains would cause further lockdowns and economic damages:
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Key Risk #4:
Should a new variant arise that is high in transmissibility, results in vaccine breakthrough, causes higher hospitalisation and death rates, this will be extremely worrying for the world.
Should such a variant emerge, risks of global lockdowns will increase and it will likely result in an equities market selloff.
Investment Opportunities in 2022
While 2022 is expected by many financial analysts to be a difficult year to navigate, there remain pockets of investment opportunities for investors and traders to consider.
US Dollar
The US Dollar Index has been strong in 2021, gaining almost 7% from 89.5 to 96 in 2021.
In large part, this is due to the Fed tapering and expected higher interest rates in 2022, both of which will reduce the quantities of USD circulating through the world economy.
Investment Opportunities #1:
As mentioned above, USD will likely do even better in 2022 if these conditions are met:
- Fed tightens even faster than markets expect due to inflation concerns. This will make the supply of USD even lesser which will result in a higher Dollar Index.
- Flight to safe havens, including demand for safe assets like US treasury bonds will increase if risks of a new damaging Covid variant emerges.
Chasing Value
2020 and 2021 were years where high growth opportunities were favoured, accelerated in kind due to the Covid pandemic. This resulted in higher than ever valuations especially for leading growth tech stocks.
It appears many institutions and professional traders are getting fatigued paying premium for high and unsustainable valuation plays.
Investment Opportunities #2:
2022 may be a year where low valuation opportunities might be favoured.
Particularly, an area where valuation remains highly attractive is Emerging Markets. The possibility for China to shift its policy mix to the upside, in the face of tightening US fiscal and monetary policies offer a strong support for China and Emerging market equities.
New Safe Havens
In 2020, the likes of Gold and Silver did very well as there was a flight to safety opportunity. However, in 2021, both metals were negative year to date.
In 2021, crypto and real estate investments did very well and replaced precious metals as winners.
It is likely that investors and traders alike will start to look into other safe haven assets in 2022, as the idea of asset class rotation will continue to persist.
Investment Opportunities #3:
The Asset classes that used to do well historically, will likely not do well in 2022, as the market continues to adopt a rotational playbook.
Therefore the only constant has been rotation, and this recurring theme will likely continue in 2022. The general message is not to stick to what has historically worked well in 2021, but to rotate out of it.
In particular, a 2022 theme might emerge whereby traders flock to new ‘Safe Haven’ assets since a tough monetary and fiscal backdrop is expected.
One asset class worth considering is the high yield bond market, which has traditionally not been considered a safe haven asset. However, this market segment has potential to do well for the following reasons:
- Credit is not expected to be an issue right now and the U.S. consumer and corporate America are quite healthy.
- Due to high inflation expectations, investors and traders will be gunning for yield. Since many high yield products offer more than 5% annual yield, it may be considered a good place to allocate into to generate returns higher than inflation.
- Rising interest rates and inflation could make longer-duration bonds risky, instead look at short duration.
Conclusion
Investors and traders will need to be very selective when it comes to investing in 2022.
Not many asset classes or previously profitable stocks that were highly successful in 2020 and 2021 will repeat their historical performance in 2022.
The only constant going forward is change, and continued rotation into specific valued plays.
2022 will be a year where only a small handful of investment opportunities will be successful, in most part because financial conditions are tightening.
Disclaimer: Please note that all the information contained in this content is intended for illustration and educational purposes only. It does not constitute any financial advice/recommendation to buy/sell any investment products or services.
If you find trading extremely difficult or are worried and not confident you can achieve portfolio profitability in 2022 – please rest assured you are not alone in feeling that way.
In fact, many professional traders, analysts and stock investors are getting ready for a tough 2022! The reason is because the stock market has run up a lot since the Covid lows, and the stock market is overpriced with high valuations. Coupled with the Fed making financial less accommodative than we had seen in the past 2 years, the only natural thing is for the stock market to take a break.
Therefore, the US stock market is expected to either trade sideways or in the worst case, experience a correction in 2022.
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If you are keen to explore alternative ways to profit from a tough market next year, we have an upcoming VIKI seminar. Click the link below to register for the event to learn how VIKI can profit when the market cannot!
