As the curtain fell on 2021 most stock markets posted strong gains, with European and UK indices leading the pack. In spite of some volatility in early December from uncertainty around omicron and speculation as to how governments would respond, a welcome Christmas rally ensued.
Are times a changing?
Equity markets finish 2021 on a high as Omicron fears abate.
Higher inflation, tapering and higher bond yields prompt a change in sector outperformance.
The UK has the best year in the past five, but fails to reach a record level.
S&P 500 hits 70 fresh highs during the year.
Omicron cases spike as it proves more infectious than Delta variant. However, data suggests Omicron is not as severe as Delta, with vaccines/booster jabs providing protection.
Self-isolation periods reduced, but inevitable disruption for businesses (and NHS in the UK).
Omicron has spread globally and China’s ‘zero-Covid policy’ could exacerbate supply chain issues.
Political turmoil in UK with ‘one more strike and he is out’ warning for the PM.
Cost of living crisis predicted in UK as energy prices surge.
Bank of England expects inflation to reach around 6% by spring 2022. Delivers a surprise interest rate hike to 0.25%.
In the US, CPI inflation touches 6.8% - highest reading since 1982.
Federal Reserve accelerates tapering and turns more hawkish.
Peoples Bank of China pumps liquidity into system in contrast to Western central banks.
OPEC+ commits to output hike in February as doesn’t see Omicron impacting demand.
The S&P 500 made a 70th record high for the year during December, albeit the tech heavy Nasdaq was only able to post modest gains for the month, as investors favoured sectors and companies that benefitted from reopening the economy in the face of growing confidence over the prognosis for omicron.
Rising energy costs made the headlines. European gas prices proved extremely volatile as Russian supplies into Europe continued to be constrained by political tensions around Ukraine. In December alone UK gas prices almost doubled in price and then subsequently halved, as US gas shipments diverted from Asia to Europe to take advantage of the higher prices. Nevertheless, UK wholesale gas prices all but trebled in price over the year. Oil also had a strong month up some 10%, on both the Russian tensions and broader supply constraints in the face of expectations of rising demand.
The arrival of Omicron was an unwelcome Christmas present. Whilst infections have grown to very high levels, the numbers requiring hospitalisation and ventilators remains a long way below peaks of previous variants. This appears to support the view that the link between cases and fatalities has been broken. As such, the major challenge for most countries is the vast numbers in isolation and in particular the impact on health systems. The key question relates to those countries, such as China, who have ‘zero covid strategies’, given how contagious omicron is. For China there is the added complication of the Winter Olympics in February.
Whilst omicron may prove to be the variant that moves covid from pandemic to endemic, it is still not without near term challenges. Potentially causing further supply chain problems and inflationary pressures.
For central bankers and consumers, inflation looks set to remain a key theme for the early months of 2022, after which it should hopefully peak. Politicians are likely to come under growing pressure in the face of a cost-of-living squeeze, particularly so on utility costs and fuel prices. In the UK, sizable increases in utility bills are expected in the Spring, which in combination with planned tax rises, will inevitably impact upon aspects of consumer spending.
December saw the US Federal Reserve further tighten monetary policy. The announcement that it would double the pace of tapering, as well as signalling greater action on interest rates, with the possibility of three increases in 2022. In addition to this, it also introduced the prospect of starting to reduce its enormous treasury bond balance sheet, which has all but doubled from its pre-pandemic level, to c. $9 trillion. The Bank of England once again surprised, this time by raising interest rates, having not done so in November, in spite of the ongoing pressures of omicron.
Following a strong year for most stock markets, 2022 starts with much to consider. Central banks continue to walk a tightrope in trying to manage inflation, without de-railing the global economy by being too aggressive in withdrawing monetary support and liquidity.
Financial markets have been significantly impacted by the expansion of the Federal Reserve balance sheet and its interest rate policy. Whilst actions to unwind this should be considered healthy, they will likely be a source of market volatility. We suspect that this will likely see a re-ordering within equity markets as the speculative froth, which had benefitted from Fed monetary policy, is removed in favour of more traditional industries.
UK equities continue to look appealing given the attractive valuations, particularly against global peers, with M&A activity likely to remain supportive. We remain positive on the outlook for 2022, but recognise there may be ‘bumps in the road’, however, with volatility comes opportunity for long-term investors.
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