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2022 beckons, so what can we expect?
1. UK Blue Chip (2021 +14.3%)
UK blue chips delivered 14.3% in index gains over 2021, (UK100 close 6,555.82; 31 Dec 2020) helped by a weak sterling, higher global bond yields, higher commodity prices and significant M&A activity. There was significant positive momentum towards the end of 2021.
The UK100 index returns over 2021, have underperformed major US and EU markets (CAC 40 +28.3%, DAX 40 +15.7%, Euronext 100 +22.7%, US S&P 500 +28.4%, TSE +21.6%).
Looking ahead to 2022, the UK short term outlook has to factor in the H1 squeeze on consumer disposable income, a key theme for 2022:-
i) Higher energy prices – Ofgem is expected to hike the price cap by c. 30% from £1,277 to £1,660 from 1st April 2022 or £138 pcm.
ii) Higher inflation – current 5.1% rate is forecast at 6% by April according to the BoE’s MPC.
iii) From 6th April – national insurance contributions will rise by 1.25%
iv) UK Base rates are currently forecast at 1% by end 2022. However the path of interest rates is likely to become more conventional in 2022 as the Brexit impact recedes and the MPC’s stance (which so far has amounted to ignoring the inflation problem) becomes untenable.
Higher inflation should benefit financial, energy and utilities by lifting net margins in the short term.
Another key theme for 2022 will be a C-19 pandemic normalization/ re-opening at a more vigorous pace than 2021. We expect normalization by H2 for airlines, hoteliers, and travel & leisure companies. We see UK GDP rising at c. 4% in 2022 despite cost and inflation headwinds.
UK index valuations remain inexpensive, partly due to the lingering Brexit impact and the composition of UK indices which are underweight, technology, software and IT companies but overweight ex growth areas such as telecoms, tobacco, transport, and low multiple sectors including miners and financials.
The resulting valuation ‘gap’ between the UK and rest of the world, evident since 2016 has reduced the UK weighting in global indices. This trend is likely to continue in 2022.
The UK forward P/E at 11.8x is less than half the US rating (22x) and at a discount to Emerging Markets (12.4x). This ‘valuation gap’ has remained consistent despite improved economic certainty over 2021, i.e. a C-19 pandemic/ GDP decline that did not trigger a bank rescue because of the robust fiscal response of the UK government.
The UK government has done a decent job during 2021 in two respects i) ensuring UK unemployment levels fell ii) the rapid delivery of the C-19 vaccine /booster program. There should be more confidence, than there appears to be, in the UK’s recovery and UK equity valuations.
Source: Yardeni Research Inc
Our expectation is a narrowing of the valuation gap will occur over 2022 as i) global technology/ IT / software retreat and ii) a global rebound pushes up areas previously hard hit. Our expectation is the recent weakness in cryptocurrencies, rising interest rates will over 2022 reduce the more extreme tech valuations. This view is, I accept, at odds with recent trends which is showing investors attaching an increasing P/E premium to US companies and hence US tech v other countries.
Our forecast for 2022 is the UK blue chip index will close above 8,000 hence a 7.75% capital return.
Our UK forecast is conservative for two reasons:-
i) rising global interest rates
ii) the need for UK budget restraint post the C-19 pandemic
2. Global stocks – MSCI World Index (3,239.28+22.5%)
The broadest international measure of equities, (23 developed countries and 85% of the free float adjusted market capitalization) delivered a 22.5% return of double its average annual returns of 11.22% (December 1978 – November 2021).
The recent index data (P/E 21.9x) and performance (-2.19%/ 1 month) and (-0.94% 3 months) suggests treading water / fatigue. This is partly explained by the weaker MSCI Emerging Markets ( -4.08%/ 1 month, -6.98% / 3 months) and the improved US dollar v world currencies.
The MSCI World Index is 69.31% composed of US equities with Japan 6.45%, UK 3.96%, Canada 3.2%, France 3.16% and other markets 13.92%.
The MSCI World index returns are in the context of a very strong year for global equity markets helped by strong US profit growth – there are now 5 US technology companies with market capitalization above US$1trn (Alphabet $1.95trn, Apple $2.94trn, Amazon $1.72trn, Microsoft $1.95trn and Tesla Inc $1.1trn with Meta Platforms (Facebook) just outside at $.96trn). This is the reason for investor willingness to pay a significant premium for US companies.
Source: Yardeni Research Inc
The significant ratings gap between USA (forward P/E 22x) and ‘All Country World’ at 14x widened over 2021 as valuations outside the USA declined.
Our view remains that global equities should continue to enjoy a C-19 pandemic rebound in 2022 – and expect normal gains in the MSCI World Index of c. 10% – the tracking ETF is iShares MSCI World (LSE: IWRD)
3. 2021 ‘Laggards’ Are they worth considering in 2022?
a) UK Gilts (10 YR) (2021 -5.1%) UK 10 year gilt prices declined over 2021 due to higher inflation both in the UK and abroad and changing rate expectations. Given inflation realities over 2021, it is surprising gilts held up so well. That is probably attributable only to the MPC’s reticence and feet dragging over the inflation issue – the debate over its approach has become far more contentious and public over the last two months. In our view the MPC has lost credibility.
If inflation exceeds 6% in 2022 we see the bearish trend persisting for gilts (current YTM 1.003%) with 10 year yields rising to 1.5%-1.75%. The gilt market is susceptible to shifting inflation expectations and the risk of a sharp correction.
b) Hong Kong Hang Seng (2021 -14.8%) the deliberate uprooting of HK’s democracy at the hands of the Chinese communist party (CCP) is a tragedy that has occurred outside of the global media spotlight during the C-19 pandemic. It has badly impacted institutional interest in HK assets. In our view this is not a situation that has any hope of reversing and is still in its early days. The unstable political situation and collapse of press independence has impaired the ability to make accurate judgments about Hong Kong. We are surprised a larger drop has not occurred.
The weak picture for long haul tourism is a further negative for HK – we do not see any positive short-term catalysts for the Hang Seng. The Hang Seng Index has de-rated to a multiple of 15.4x and in our view is poised to go lower.
HK’s problems are relevant to HSBC Holdings, Prudential (which took the strategic decision two years ago to divest the safe regions and focus on Asia/ Africa), Standard Chartered and to a far lesser extent Burberry (8% of revenues). Arguably the latter two are sufficiently diversified. HSBC needs a reconsider splitting off its HK operations which runs contrary to a nearly three decades old strategy of using HK as a cash cow for overseas adventures.
c) Iron Ore (62% Fe, CFR China) (2021: -30%) Iron ore had a rollercoaster 2021. After opening near $160/MT the price reached $211.80 / MT in August before declining to $112/MT by December.
Over Q4 2021 the main negatives:-
i) strict curbs imposed by the Chinese government on Chinese steel mill output
ii) a weaker outlook for Chinese property markets
iii) higher Brazilian production were sufficient to ensure one of the sharpest price reversals in the last 20 years. Was the price collapse predictable during the heady July days? Certainly.
We expect iron ore volatility in 2022 to remain at elevated levels. Supply/demand factors appear more balanced heading into 2022. But iron ore is sensitive to the environmental problem posed by CO2 emissions in the steel making process. Recent industry initiatives, using clean power, rechargeable trucks and loaders are a small step in the right direction, but the industry needs to find a way of cutting emissions in manufacturing. To reach climate objectives, China is likely to employ steel production curbs more extensively.
Overall we expect iron prices to settle in the $90/ MT- $120/ MT range – in our view the iron ore miners are attractive for longer term investors.
We remain positive on UK and global equities going into 2022 given the expected global GDP bounce from easing C-19 restrictions, though given current elevated valuations, and headwinds, capital returns are likely to be more modest than in 2021.
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