Outlook 2022: Flying at a Lower Altitude

Outlook 2022 Introduction

As we peer over the horizon, with the strongest annual economic growth in nearly 50 years almost behind us, we anticipate growth will return to a lower altitude. Our base case for 2022 is consistent with consensus expectations of slower, but above average, real global economic growth and elevated global inflation that should subside in the second half of the year. Higher inflation has remained stickier longer than expected, as above average goods demand and labor shortages have created supply side bottlenecks. Experienced pilots prepare for turbulence and 2022’s forecast comes with potential storm clouds, including those related to the unwinding of extraordinary levels of fiscal and monetary stimulus, persistent inflationary pressures, a Chinese regulatory-driven slowdown, and COVID-19. As the Omicron variant poignantly reminds us, the virus may continue to disrupt economies and markets, even as the world is adapting aided by medical breakthroughs. High valuations also make many markets unusually vulnerable to negative surprises and limit their upside potential. While our outlook is positive, diversification is required.

Positive macroeconomic conditions should provide support for sustained earnings growth, boosting prospects for equities to outperform high-quality bonds even accounting for high valuations. We anticipate interest rates will be under pressure as central banks pull back support, but moderating inflation pressures and gradual monetary policy normalization should limit rate increases. Within equities, our most contrarian view is for Chinese A-shares to outperform global equities next year. Targeted monetary and fiscal support should boost A-shares at a time when developed market policymakers are looking to tighten. Beyond China, we are skeptical that other emerging markets will deliver strong equity returns given their narrowing GDP growth premium relative to developed markets and the potential for fiscal and monetary policy tightening.

As private investments’ stellar returns continue to attract capital, the lines between public and private managers are blurring. In fact, more non-VC funds are investing in venture capital deals than VC funds! With companies choosing to stay private longer, many managers, including hedge funds, long only funds, and venture capital funds are seeking to invest in private companies prior to and through public offerings. Indeed, 17% of our US venture capital index consists of public companies. Several less-trafficked private capital destinations, like Asian markets (outside of the already commonplace Chinese destination) and more specialized European strategies (e.g., tech and health-care focused strategies) are also worthy of pursuit.

Equity market prospects are never homogenous and 2022 looks set to offer a wide dispersion in valuations at a time when earnings contributions across sectors is expected to become more balanced. Such conditions offer active managers greater opportunity to distinguish themselves (hopefully to the upside!). Interest in active management will also benefit from increased shareholder engagement—the other E in ESG. Investors concerned about long-term portfolio resilience amid heightened systemic risks in climate change and social inequality are engaging with managers (and managers with portfolio companies) to seek change. We expect the trend toward active engagement practices to gain momentum in 2022 as investors increasingly move to align portfolios with net zero emission targets.

Continued strong economic growth will support real estate and infrastructure investments. We prefer investments focused on secular trends, such as the growing demand for healthcare and broadband usage, digitization, and decarbonization, given generally elevated valuations and disruptive trends in some sectors (e.g., retail and office real estate). Attractive opportunities exist in medical properties, data centers, digital infrastructure and renewables. For investors looking for other attractive sources of diversification to shelter from potential storm clouds, specialty finance and credit opportunities are less trafficked than other private credit areas and offer appealing returns across the credit cycle. Global macro managers also offer appeal in the current environment, given these managers tend to be long volatility.

Our compilation of investment views for 2022 delve more deeply into these lower-altitude investment themes and opportunities.