WisdomTree Q1 2022 Economic and Market Outlook
By Scott Welch
“I just came by to see what state my condition was in”
(By Kenny Rogers and the first edition, 1967)
When reviewing the current state of the global economy and investment markets, we recommend focusing on market signals and eliminating market noise. We believe that the top five economic and market signals that provide perspective on where to go are GDP growth, earnings, interest rates, inflation and central bank policy.
While slowing from the pace of 2021, U.S. economic growth should remain reasonably strong in 2022, especially if (as we expect) COVID-19 moves further and further into the rearview mirror. Consensus estimates for GDP growth in 2022 are around 4%.
The Atlanta Fed’s “GDPNow” estimate pegs fourth-quarter 2021 GDP growth at 6.8%. We see this as the potential start of another cycle of “economic reopening” in the first half of 2022.
Global growth (emphasis on the purple line in the charts below) should also be generally positive. Global growth in 2021 was ~5.6% and the estimate for 2022 is ~4.5% to 5.0%.
Translation: A potentially volatile but overall positive environment for risk-on assets. There are several “known unknowns” in this economic forecast, including:
- The end result of the proposed ‘Build Back Better’ plan (or, as is more likely, specific elements of it)
- The continuing evolution of the coronavirus pandemic and corresponding national, state and local responses
- Rising geopolitical tensions between the United States, China, Russia, Europe and Iran.
The fourth quarter 2021 earnings season in the US has just begun, and the outlook is for weaker but still positive revenue and earnings growth.
Non-US earnings should also be reasonably strong in 2022. Valuations outside the US continue to look relatively attractive compared to the US, especially Japan.
Translation: A still positive environment for global risk assets. We believe there will be a tug of war in valuations between positive earnings and rising interest rates over the course of the year. We also believe that ‘quality’ (i.e. companies with strong balance sheets, earnings and cash flow) may become increasingly important as we navigate the potentially volatile seas of 2022.
Interest rates and spreads
While rates have risen across the yield curve (a trend that is likely to continue), real action has been focused on the short end of the curve (orange line), as the market reacts to higher inflation. high and a more hawkish Fed.
Credit spreads remain tight (suggesting investors are comfortable with potential default rates) but not out of step with historical levels. However, the selection of quality securities remains essential.
Translation: We maintain our position of underweight duration and overweight credit relative to the Bloomberg Barclays US Aggregate Bond Index, with a focus on quality stock selection, particularly in high yield. Corporate balance sheets are strong, so coupons should be relatively safe. We see pockets of potential opportunity in interest rate hedged bonds (particularly high yield), floating rate treasury bills and alternative credit. But now is not the time to take on excessive risk in your fixed income portfolio.
Inflation is the economic issue of the year – the Fed apparently got more “hawkish” but may have waited too long. All eyes will be on the behavior and actions of the Fed as we move forward into 2022. Three rate hikes are priced into the market right now – we think we could see four.
Global commodities are rising on expectations of an “economic reopening” regime in the first half of 2022. Even precious metals, after a generally poor 2021, have recently rallied as inflation fears grow.
Translation: Inflation is the story for at least the first half of 2022. The Fed is becoming increasingly hawkish but must walk a “tight line” between controlling inflation and throttling economic growth – it won’t be easy. Historically, equities have provided a reasonable hedge against moderate inflation, and we also maintain our position in broad-based commodities within several of our model portfolios.
Central Bank Policy
After waiting perhaps too long, the Fed has become increasingly hawkish. The market expects at least three rate hikes in 2022, and we believe there could be four. Moreover, the Fed has signaled that it could intervene as early as March with its first rate hike. Market volatility increased accordingly. The fed funds futures market is now pricing a fed funds rate of 1.00% by the end of 2022 – we think it could end up being even higher than that.
Translation: All eyes are on the Fed. Economic growth and corporate earnings should generally be positive for risk assets, but the “offset” is the direction and level of interest rates and Fed actions over the year.
When we focus on what we think are the main market signals, the “condition our condition is in” is somewhat mixed. Economic growth and earnings should be positive, COVID-19 and its variants should be in the rearview mirror, and the impasse in Washington, DC, is generally positive for stock markets.
We believe that “fundamentals” will matter again and that we could benefit from another “economic reopening” market regime in the first half of 2022, which could favor value-oriented, small-cap, quality and equity-oriented stocks. dividends.
But inflation, interest rates, Fed behavior and legislative uncertainty are all weighing on market sentiment. So, while we are cautiously optimistic in our outlook for 2022, we believe we may face increased volatility. We continue to recommend favoring a longer-term time horizon and the construction of “all-weather” portfolios, diversified both in terms of asset classes and risk factors.
Scott Welch, CIMA, Chief Investment Officer – Model Portfolios
Scott Welch is the IT Director of Model Portfolios at WisdomTree Asset Management, a provider of factor ETFs and differentiated model portfolio solutions. In this role, he oversees the creation and ongoing management of the WisdomTree Model Portfolio Solution Set. He is also a member of WisdomTree’s Asset Allocation and Investment Committees. Prior to joining WisdomTree, Scott was the Chief Investment Officer of Dynasty Financial Partners, a provider of outsourced investment research, portfolio management, technology and practice management solutions for RIAs and transition advisory teams. towards independence. He remains an outside member of Dynasty’s investment committee. He serves on the IWI Board of Directors, the ABA Wealth Management & Trust Conference Advisory Board, and the Editorial Advisory Boards of the Journal of Wealth Management and the IWI Investments & Wealth Monitor. Scott holds a BS in Mathematics from the University of California at Irvine and an MBA with a concentration in Finance from the University of Massachusetts at Amherst.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.