Analyst Weekly – Outlook for another good year

Summary

Focus: Our investment outlook for 2022

We set out a roadmap for a rare 4th consecutive year of good returns in 2022. Our economic outlook for still high growth, a slow interest rate lift-off, and less inflation worry, is positive for equities, commodities, and crypto, but not for bonds and gold. Diversification is key, as the rally ages. We favour growth-sensitive and cheaper cyclicals, like financials and commodities. Tech is still well-supported, driving many key investment themes, from EV’s to renewables.

Growth rebound versus rising virus cases

Equity markets treaded water, led by tech, digesting their early Santa rally and with signs of strengthening economies in US and China after both saw above expectations retail sales and industrial production. This optimism offset rising virus case concerns, especially in Europe, and continued inflation worries. The recent USD surge continued, contributing to the oil price slump, whilst crypto assets weakened sharply. See our latest presentation Here.

Silver lining of USD strength

The USD has outperformed near all currencies this year. This has been a headwind for emerging markets, commodities, and US tech. But it helps the profits of many UK, European, and Japanese companies that sell a lot overseas.

Rise of the ‘new’ conglomerates

Announced conglomerate breakups by GE (GE), Johnson & Johnson (JNJ) and Japan’s Toshiba show the quickly changing face of old-school conglomerates. They are now increasingly being replaced by ‘new’ conglomerates: big techs, from Meta (FB) to Alphabet (GOOGL), and the huge and growing private equity industry.

‘Breakfast’ commodity costs a bigger problem

A 55% surge in our ‘breakfast’ cost’ index the past year hurts emerging markets, and worse is to come. ‘Producers’ like Mosaic (MOS) benefit, whilst ‘users’ like Kraft (KHC) hurt.

Bitcoin falls below $60,000

Crypto assets weakened and Bitcoin (BTC) fell below $60,000. The long-awaited bitcoin ‘taproot’ upgrade was completed the prior weekend, and US infrastructure bill signed. This bill included tightened crypto tax reporting requirements. Avalanche (AVAX) was one of the few notable exceptions to the broad sell-off.

Oil slumped on Strategic Reserve threat

Lower oil prices and a stronger USD held back commodities, even as agricultural prices and European natural gas rallied further. US-led threats to release oil from their strategic reserves hit prices, as they hoped.

The week ahead: Holiday season kicks off

1) Take the global growth ‘pulse’ with forward looking PMIs in UK, Europe, US. 2) Minutes from last Fed meeting gives insights into pace of policy tightening. 3) US thanksgiving holiday and ‘black Friday’ kick-off holiday spending. 4) Shortened earnings week includes results from Zoom (ZM), Analog Devices (ADI), and Deere (DE).

Our key views: Virus risks rising again

We see a positive outlook of 1) vaccine rollout and economic re-opening, and 2) still huge policy support. Risks are focused on a more aggressive Fed, with inflation high, and Europe’s surging new virus cases, hitting growth outlook again. We like equities, commodities, crypto, and are cautious fixed income, and the USD.

Top Index Performance

1 Week 1 Month YTD
DJ30 -1.38% -0.21% 16.32%
SPX500 0.32% 3.37% 25.08%
NASDAQ 1.24% 6.41% 24.59%
UK100 -1.69% 0.26% 11.81%
GER30 0.41% 3.97% 17.79%
JPN225 0.46% 3.27% 8.399%
HKG50 -1.10% -4.12% -8.01%

*Data accurate as of 22/11/2021

Market Views

Growth rebound versus higher virus cases

  • Equity markets treaded water, led by tech, digesting there recent strong rebound and with signs of strengthening economies in US and China after both saw above expectations retail sales and industrial production. This optimism offset rising virus case concerns, especially in Europe, and continued inflation worries. The USD surge continued, contributing to the oil price slump, whilst crypto assets weakened sharply. See our latest presentation here. Also, REGISTER for our year ahead 2022 webinars.

Santa came early this year

  • S&P 500 has rebounded 9% from October low, with the seasonal ‘Santa rally’ coming early. We are at our 4,700 end year target, but with more for next year to 5,050. This ‘Halloween’ effect starts a seasonally strongest six months of the year, as investors position for the year ahead, and companies outline year ahead views.
  • There is a rotation to growth-sensitive sectors, with consumer discretionary, commodities, industrials and tech normally leading. The May October defensive leaders, such as consumer staples, utilities, and healthcare, set to lag.

Silver lining of USD strength

  • US dollar has conquered all, outperforming 85% of the 30 major global currencies we track this year. It has been boosted by the sharp re pricing of Fed interest rate hikes (with a 70% chance of starting in June) and rebounding GDP outlook (Atlanta Fed NOWCast 8.2% Q4 growth).
  • USD strength is problem for emerging markets (higher debt costs), commodities (pricier to buy), and US tech (57% sales from overseas). But a benefit for many UK, EU and Japanese stocks. They sell a lot overseas and are more competitive with weaker local FX (see chart).

Conglomerates are different, not dead

  • Announced conglomerate breakups by GE (GE), Johnson & Johnson (JNJ) and Japan’s Toshiba are huge and highlight for many the long-running ‘death of the conglomerate’. We are not so sure. Conglomerates are changing but far from dead.
  • Surprisingly, most of these spin-offs have not performed well. Whilst Berkshire Hathaway (BRK) is still the largest non-tech US stock. Also, ‘Big-techs’ like Meta (FB) and Alphabet (GOOGL) look increasingly like conglomerates. Similarly, private equity may ‘new conglomerates’, with $3 trillion to invest and large and diverse holdings.

‘Breakfast’ commodity costs a bigger problem

  • A 55% surge in our proprietary ‘breakfast’ cost index the past year. This is led by oats (+130%) and coffee (+70%). This is outpacing the broader commodity rally and piling cost pressures on many. This is boosting inflation and interest rates in emerging markets (EM) especially, and contributes to our investment caution there. 72 of 77 interest rate hikes this year are from EM.
  • Worse may also be to come. La Nina weather disruption is forecast for this winter and could impact key southern hemisphere producers. Ag ‘producers’ from Deere (D) to Mosaic (MOS) have been benefitting, whilst big ag ‘users’ like Kraft (KHC) and General Mills (GIS) are suffering.

Who’s FX exposed? Percent of overall company revenues from overseas

Bitcoin falls below $60,000. Avalanche surges

  • Crypto assets weakened and Bitcoin (BTC) fell below $60,000. The long-awaited ‘taproot’ upgrade was completed last weekend, and US infrastructure bill signed. This bill included tightened crypto tax reporting requirements.
  • Layer one proof-of-stake blockchain Avalanche (AVAX) dodged the broader crypto sell-off. It benefitted short term from a related strategic alliance announcement with big-4 accountant Deloitte. In recent months it has been boosted by the launch of the ‘Avalanche rush’ incentive programme, bringing the large Aave and Curve DeFi protocols to Avalanche.

Oil threatened by Strategic Reserve supplies

  • Low oil prices and a stronger USD held back commodities. This offset a new surge in European natural gas prices, as the Nordstream II pipeline opening was delayed. Also higher agricultural prices, ahead of potential La Nina weather disruption. EU carbon credits rose further after COP 26, and now +105% this year.
  • Oil prices have been pressured by the outlook for the US leading major countries in releasing oil from their Strategic Petroleum Reserves. They hope to lower prices, and ease inflation pressures. We fear this may backfire, be seen as ineffective, and as desperate. Major countries only hold oil reserves equivalent to 15 days of demand. These reserves are meant for true ‘emergencies’, limiting the amount they will sell.

US Equity Sectors, Themes, Crypto assets

1 Week 1 Month YTD
IT 0.95% 5.39% 29.09%
Healthcare -1.10% 1.11% 13.79%
C Cyclicals 2.41% 7.85% 23.59%
Small Caps -2.85% 2.33% 18.65%
Value -1.53% 0.00% 20.03%
Bitcoin -9.55% -12.80% 101.75%
Ethereum -7.99% 4.28% 472.70%

Source: Refinitiv

The week ahead: Holiday season kicks off

  1. Latest purchasing manager indices (PMI) in Australia, Japan, UK, Europe, US (Tue) will give the pulse of global growth as we navigate the divergent covid and rising inflation backdrop.
  2. The Fed is in focus (Wed) with its last meeting minutes, and giving insights into the pace of their policy tightening. We also see their favoured PCE inflation measure, last +4.4%. Pres. Biden due to announce new Fed chair.
  3. The holiday shopping season kicks of with US Thanksgiving holiday (Thur) and ‘Black Friday’ shopping day. US holiday retail sales are forecast to grow a record +8.5-10.5% this year
  4. See earnings including Zoom (ZM), chipmaker Analog Devices (ADI), life science Agilent (A), Medtronic (MDT), and ag stock Deere (DE).

Our key views: Virus risks rising again

  • A positive scenario of 1) global vaccine rollout and economic re-opening, 2) still large support of low interest rates and fiscal spending.
  • The main risk is Fed policy tightening, with inflation broadening. But markets are already pricing at-least two US interest rate increases next year. Virus risks are also rising again, with new cases in Europe up by 3x in last six weeks.
  • We focus on cyclical assets that benefit most from the rebound: commodities, crypto, small cap, and value. We are more cautious on fixed income, the USD, defensive equities and China.

Fixed Income, Commodities, Currencies

1 Week 1 Month YTD
Commod* -0.47% -1.39% 31.08%
Brent Oil -4.01% -8.29% 52.09%
Gold Spot -1.12% 2.99% -2.88%
DXY USD 0.99% 2.59% 6.82%
EUR/USD -1.35% -3.07% -7.58%
US 10Yr Yld -1.76% -8.73% 62.98%
VIX Vol. 9.94% 16.07% -21.27%

Source: Refinitiv. * Broad based Bloomberg commodity index

Focus of Week: Outlook for another good year

Roadmap to a very rare 4th consecutive year of good returns

Our outlook for a reopening and reflationary world in 2022 remains positive for most assets, despite the very strong returns this year. This should favour equities, commodities, and crypto, whilst keeping bonds and gold under some pressure. US equities have only seen four straight years of double-digit returns once before in the last five decades. But we think we could get close next year. Consensus earnings growth expectations seem too low to us, with GDP growth still strong and companies showing they can offset rising cost pressures and keep profit margins high. We see earnings growth double consensus forecasts (see table). We also see high valuations as more sustainable than perceived, supported by still low bond yields and the large weight of high-valuation and very profitable tech companies. Valuations will ease from the current high 22x price/earnings ratio, but we do not think by as much as many fear.

Economic scenario of still high growth, a slow interest rate lift-off, and less inflation worry

US and global GDP growth is set to naturally slow next year but to remain strong and well-above long term average levels. This is supported by still re-opening economies and very low interest rates. These rates will be rising with the Fed expected to hike interest rates twice next year starting in June. But these are still very low rates, and the increase will only be gradual. The pace will depend on inflation. Consensus is that inflation pressures ease as the pace of the economic rebound slows, and supply chains adjust. The USD is seen relatively stable after its strength this year. Oil prices are seen lower, but still high versus history.

Diversification is especially important as the equity rally ages

Diversification will be key next year, both to manage the risks associated with this ageing equity bull market and take advantage of the broad global economic growth. US markets will benefit from still strong growth, low interest rates, and its world-leading tech sector. International markets, such as UK and Europe, from their stronger earnings recovery, more GDP growth sensitive stock market composition, and their much lower valuations. Emerging Markets will likely benefit from a better year for its dominant market China, with valuations now better reflecting its economic slowdown and recent tech policy crackdown.

Tilt to cyclical assets more sensitive to growth, and with cheaper valuations

We expect the growth-sensitive ‘cyclical’ sectors such as commodities, industrials, and financials to lead, along with small caps and ‘reopening’ sectors (such as travel and tourism). They are also some of the cheapest sectors. Tech will be fine, helped by is structural growth and ‘fortress’ balance sheets, but we do not see it leading next year. The laggards may be the ‘defensive’ sectors such as healthcare and consumer staples, that have little sensitivity to economic growth, but will be impacted by higher bond yields. We are also seeing the continued rise of thematic investing, unconstrained by sector or geography. Tech disruption continues to accelerate, benefitting segments from EV’s to renewables and the metaverse.

Consensus economic and market comparison: 2022 vs 2021

Key Views

The eToro Market Strategy View
Global Overview Positive scenario of 1) global vaccine rollout and economic re-opening, 2) support from low interest rates and government spending. Main risk is from US Fed monetary policy tightening, but will be well-signalled and very gradual. Economies are increasingly resilient new virus case ‘waves’. Focus on most growth sensitive assets: equities, commodities, crypto, small cap and value. Relative caution on fixed income, USD, defensive equities and China.

 

Traffic lights* Equity Market Outlook
United States World’s largest equity market (55% of total) seeing strongest GDP recovery in 30-years driving earnings upside ‘surprise’, and a rare third consecutive year of 10%+ equity market returns. Valuations at 21x P/E are 25% above historic levels but supported by still low bond yields and strong earnings growth outlook. See further cyclicals and value catch-up, after a decade of underperformance, whilst tech is well supported by its structural growth outlook.
Europe & UK Latest to benefit from vaccination surge and much more economic re-opening to go. Equity markets helped by 1) a greater weight of cyclical sectors, and lack of tech, 2) 25% cheaper valuations vs US, 3) decade of under performance made under-owned by global investors. A robust EUR a help for investors, as is multi-year €750bn ‘Next Generation’ fiscal support. With 50%+ company revenues from overseas is exposed to global trends.
Emerging Markets (EM) China, Korea, Taiwan dominate EM, with 60% weight, and is more tech-centric than US. China equities hurt by tech regulation crackdown, property sector debt, and slower GDP growth. But this is increasingly well-priced. LatAm and Eastern Europe have more upside to global growth recovery, a weaker USD, and higher commodities.
Other International (JP, AUS, CN) Canada and Australia benefit from strong equity market weight in commodities and financials, as global growth rebounds and bond yields set to rise. Japanese equities among cheapest of any major market and vaccination rates accelerating, but has structural headwinds of low GDP growth, an ageing population, and world’s highest debt.

 

Traffic lights* Equity Sector & Themes Outlook
Tech The broad ‘tech’ sector of IT, communications, and parts of consumer discretionary (Amazon, Tesla), dominates US and Chinese markets. Expect a more subdued 2021 after dramatic 2020 rally. But are structural stories with good growth, high profitability, and clean balance sheets that justify high valuations, and should continue to rise.
Defensives Healthcare, consumer staples, utilities, and real estate sectors traditionally offer more defensive cash flows, less exposed to changes in economic growth. This has also made them more sensitive to rising bond yields. We expect them to relatively underperform in a more cyclicals focused environment with earnings strong and yields rising.
Cyclicals We expect cyclicals – consumer discretionary (autos, apparel, restaurants), industrials, energy, and materials, to lead market performance. They are most sensitive to the sharp economic recovery and higher bond yield outlook, with more sensitive businesses, depressed earnings, cheaper valuations, and have been out-of-favour for many years.
Financials Financials will benefit from the GDP growth recovery, with higher loan demand and lower defaults. Similarly, they benefit from higher bond yields outlook, charging more for loans than they pay for deposits. Sector has cheapest P/E valuation of any, and regulators recently giving flexibility to pay large 8-10% dividend and buyback yields.
Themes We favour small cap vs large, on more GDP growth exposure, earnings upside, and domestic focus. Similarly, value over growth on GDP recovery, lower valuations, under-ownership after decade under-performance. Dividends and buybacks recovering with cash flows. Power of dividends under-estimated, at up to 1/2 of total long term return.

 

Traffic lights* Other Assets
Currencies We see recent USD strength easing as the rest-of-world GDP growth recovery accelerates, and fears over a virus ‘third wave’ ease. A stable or weaker USD traditionally supports Emerging Markets, commodities, and large US foreign earners, such as the tech sector, and could be a modest headwind to large exporters, such as Europe.
Fixed Income US 10-year bond yields to rise modestly as inflation above 2% average Fed target, ‘real’ inflation-adjusted yields negative, Fed to gradually tighten policy. Will be modest as inflation expectations already high, wide spread to other market bond yields, and structural headwinds of all-time high debt, poor demographics, and low productivity.
Commodities Supported by GDP growth rebound, ‘green’ industry demand, years of supply under-investment. China GDP and property sector are short term concerns. Industrial metals and battery materials seem best positioned, whilst oil price supported by only slow return of OPEC+ supply. Gold hurt by outlook for higher bond yields.
Crypto Institutionalization of bitcoin market barely begun, as asset class benefits from very strong risk-adjusted returns and low correlations with other assets. Altcoins have outperformed as see broader interest and use cases. Clear supply rules a benefit as inflation rises. Volatility remains very high, with the 15th -50% pullback of the last decade.

 

*Methodology: Our guide to where we see better risk-adjusted outlook. Not investment advice.
Positive Overall positive view, and expected to outperform the asset class on a 12-month view.
Neutral Overall neutral view, with elements of strength and weakness on a 12-month view
Cautious Overall cautious view, and expected to underperform the asset class on a 12-month view

Source: eToro

Analyst Team

Global Analyst Team
CIO Gil Shapira
Global Markets Strategist Ben Laidler
United Kingdom Adam Vettese
Mark Crouch
Simon Peters
France Antoine Fraysse Soulier
David Derhy
Iberia/LatAm Javier Molina
Poland Pawel Majtkowski
Romania Bogdan Maioreanu
Asia Nemo Qin
Marco Ma
Australia Josh Gilbert

 

COMPLIANCE DISCLAIMER

This communication is for information and education purposes only and should not be taken as investment advice, a  personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been  prepared without taking into account any particular recipient’s investment objectives or financial situation and has not  been prepared in accordance with the legal and regulatory requirements to promote independent research. Any  references to past or future performance of a financial instrument, index or a packaged investment product are not, and  should not be taken as, a reliable indicator of future results. eToro makes no representation and assumes no liability as  to the accuracy or completeness of the content of this publication.

69 views