The “starting 11” questions on investing for 2022

1.  Where are we in the economic cycle?

The answer varies depending on where we are in the world. Overall, we believe the global economy is still in the early to mid part of the economic cycle. The fastest recovery growth phase is likely to be behind us in developed economies such as the U.S. and Europe, but it is still accelerating in Asia and emerging markets.

China was the first economy to make a full recovery in 2020, but a combination of policy normalization, regulatory changes, a slowdown in the real estate market and power disruptions slowed momentum in 2H 2021. We believe China’s growth rate could start to stabilize in 1H 2022 with modest fiscal and monetary stimulus. Domestic demand and services could replace exports in delivering growth for China in 2022.

In the U.S., the reopening of the economy and aggressive fiscal stimulus have boosted growth in 2021. With economic activities returning to pre-pandemic levels, the U.S. is expected to expand along its long-term trend growth. Both consumption and corporate investment have picked up in 2021. For additional growth momentum, the U.S. would need to resolve several supply-side constraints including labor shortages. A gradual normalization of monetary policy is unlikely to constrain growth. We continue to believe the Federal Reserve’s (Fed’s) policy decisions would be driven by the progress of its economic recovery.

Despite a lackluster economic performance in 2021, Asia and emerging markets are expected to be in a stronger position to rebound. So far, technology exporters such as Taiwan and South Korea have benefited from strong global demand and have led Asia’s recovery. In contrast, India and Association of Southeast Asian Nations (ASEAN) have lagged behind with economic activities still below pre-pandemic levels. Immunity from both vaccination and infection is rising in these markets, and this should allow governments to treat COVID-19 as an endemic and further open up their domestic economies and borders. Moving from pandemic to endemic could allow for a more comprehensive recovery, especially for Asian economies that are dependent on tourism and people flow.

Overall, we expect to see the impulse of global growth shift from developed economies to Asia and select emerging markets. This also implies that earnings upgrades should be concentrated in these regions, especially for cyclical sectors serving their domestic markets. There is also the difference in goods versus services, where the former has made a robust recovery as more consumers shift to online shopping. Services, especially travel and tourism, should have more room to catch up as economies transition into the endemic phase.

The global economy should continue to grow, but the bright spot could shift away from the U.S. and Europe to Asia
EXHIBIT 1: QUARTER-OVER-QUARTER REAL GDP GROWTH

Source: J.P. Morgan Economic Research, J.P. Morgan Asset Management.
Y-axis has been cut to maintain a reasonable scale.
Guide to the Markets – Asia. Data reflect most recently available as of 29/11/21.

3.  What changes are likely for China’s economic model?

China was the first economy to suffer from the fallout of the COVID-19 pandemic, but also the first to rebound and make a full recovery in 2020. The strong momentum continued into 1H 2021 and Chinese policy makers took the opportunity to implement a variety of reform measures.

On the minds of Chinese policy makers are long-term challenges such as environmental sustainability, low population growth, greater self-sufficiency in technology output and financial stability. To tackle these issues, corresponding initiatives have been introduced, including decarbonization, education reforms, property market curbs, anti-trust in the technology sector and credit control. Alongside these policies, China’s leaders have set a goal for common prosperity, i.e. more equal distribution of income and wealth among its population, which forms a solid basis for sustainable growth.

Admittedly, these policy initiatives may help China reset its economic model and improve growth potentials in the long run. However, given the long-term characteristics of these policies, it is also critical to balance between long-term sustainability and short-term stability. Since July 2021, the intensive regulatory actions and property market curbs have weighed on domestic investment and consumption. Hence, policy easing is expected in 4Q 2021 and 1H 2022 to stabilize the economy, although the scale could be moderate.

Moving into 2022, credit conditions in the domestic property market may continue to improve to support first-time home buyers and housing construction projects. Meanwhile, investment by local governments could rebound as government financing has picked up since September 2021. Compared with 2021, Chinese export growth is likely to slow as Southeast Asian exporters recover from the pandemic and take some of China’s share in global trade. Domestic demand may become the major growth driver in China’s economy.

That said, the scale of any stimulus might be far smaller than those in 2008 and 2020. The government will adhere to those long-term goals, while only relying on policy easing to prevent a hard landing. The emphasis could also be on the quality, rather than the pace, of economic growth. Therefore, the overall gross domestic product (GDP) growth may slow down to less than 5%. This could lead to slower growth in aggregate corporate earnings, which would require more active management in company selection.

In 2022, investors should consider the sectors with ample policy tailwinds. This implies decarbonization and new energy, self-sufficiency in technology hardware and resilient domestic technology supply chains should be the major themes to follow. Meanwhile, opportunities may appear in the consumer staples and services sectors when growth stabilizes and valuations still remain attractive. 

China relies on a broad range of regulatory reforms to boost its long-term growth potentials, which lead to pressures on short-term growth
EXHIBIT 3: CHINA’S RECENT REGULATIONS WITHIN DIFFERENT SECTORS

Source: Various news sources, J.P. Morgan Asset Management.
*PBoC: People’s Bank of China; CBIRC: China Banking and Insurance Regulatory Commission; CSRC: China Securities Regulatory Commission; SAFE: State Administration of Foreign Exchange. **SAMR: State Administration for Market Regulation oversees all manner of market controls, including regulating anti-competition behavior, intellectual property rights, drug safety supervision and issuance of business licenses etc. ***CAC: Cyberspace Administration of China is the central internet regulator, censor, oversight and control agency for China.
The companies/securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell.
Guide to the Markets – Asia. Data reflect most recently available as of 29/11/21.

5.  Would central banks turn more hawkish?

Some developed market central banks are slowly moving away from their ultra-loose monetary policy as economic recovery gains ground. They are also worried that inflation could be more persistent than initially thought. For example, the Reserve Bank of New Zealand twice raised its policy rate by 25 basis points (bps). The Bank of Canada ended its quantitative easing program and indicated it could be looking to raise rates as early as 2Q 2022. The Reserve Bank of Australia has stepped away from defending its bond yield target. The Bank of England (BoE) also has indicated the need to act and cap inflation pressure. These shifts in policy stance have pushed short-term interest rates higher as investors factor in the possibility of central banks acting sooner and more aggressively.

Yet, not all developed market central banks are hawkish. The Bank of Japan is still forecasting below-target inflation for the next two years. The European Central Bank is also adopting a patient approach in normalizing policy. With inflation in Europe and Japan still subdued, we should expect interest rates in these economies to stay low for an extended period of time, which means European and Japanese investors would be looking for income in other parts of the world, including Asia and emerging markets.

Some emerging economies in Latin America and Central and Eastern Europe have already embarked on a tightening path. Brazil, Russia and Mexico have already raised their policy rates in 2021 in response to higher inflation. Central banks in Asia have been more muted in response. Only Sri Lanka and South Korea have raised policy rates so far. Since most Asian economies are still at an early phase of the economic recovery, their central banks may see higher inflation as temporary. They could allow policy rates to stay supportive for much of 2022. If the Fed starts to raise policy rates in late 2022, or early 2023, this could prompt Asian central banks to think harder about hiking rates. Still, we believe the pace is likely to be gradual.

An exception here is China where the economic momentum has slowed in 2H 2021. The People’s Bank of China (PBoC) is unlikely to cut lending rates or reserve requirements to boost growth, and instead, could rely on open market operations and industry-specific measures to provide the financial system with adequate liquidity, especially if property developers’ financial and liquidity stresses deteriorate.

As the bright spot of growth moves around the world, we expect developed market central banks to turn more hawkish first. Asian central banks could be more willing to wait for an economic rebound to take shape before they consider raising policy rates. Despite the prospects of higher policy rates and government bond yields in the next 1-2 years, real interest rates are likely to remain low or even negative in some cases.

Some central banks, such as the Fed and the BoE, could see policy rates lifting off in 2022
EXHIBIT 5: G4 CENTRAL BANK POLICY RATES AND MARKET EXPECTATIONS

Source: J.P. Morgan Asset Management; (Left) FactSet; (Right) Bloomberg L.P.
G4 are the Bank of England, the Bank of Japan (BoJ), the European Central Bank and the U.S. Federal Reserve. *The BoJ has adopted a three-tier system in which a negative interest rate of -0.1% will be applied to the policy rate balance of the aggregate amount of all financial institutions that hold current accounts at the BoJ. **Expectations are derived from the 3-month moving average of the overnight index swap (OIS) forward rates.
Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 29/11/21.

7.  Will the Fed start raising interest rates in 2022?

It is increasingly likely that the Federal Reserve could start raising policy rate in 2022. Recent market expectations show this could come as soon as the summer. The precise timing of this shift will depend on how inflation and the job market evolve in the next 12 months. The Fed’s summary of economic projections in September 2021 shows 9 of 18 participants expect the central bank to raise policy rates by at least 25bps before the end of 2022, compared with just seven in June, and the rhetoric from committee members on raising rates is rising.

It is important to consider the Fed’s policy objectives of price stability and full employment. While inflation is likely to ease in 1H 2022 as low base effects fade and high energy prices revert to a more sustainable level, sticky housing costs and wage inflation could keep headline inflation slightly above the Fed’s long-term 2% target. Taking into account the average inflation-targeting framework that was introduced in September 2020, price pressure should prompt the Fed to act to ensure price stability.

In terms of full employment, the latest U.S. unemployment rate is at 4.3%, and this should gradually decline over time. Demand for workers continues to be strong, with over 10 million job openings as of September 2021 versus 7.7 million unemployed persons. The low participation rate and disconnect between demand and supply could be due to the COVID-19 pandemic impacting workers’ decisions to seek work and demand for higher wages, as well as an increasing number of retirees. Overall, the Fed’s own projection of the unemployment rate falling below 4% by the end of 2022 seems realistic and this would imply the U.S. job market is back to full employment, especially if wage inflation remains stubbornly high.

The pace of policy rate increases in the next 2-3 years is arguably more important than the pace of the first hike. The Fed’s median projection suggests around three 25bps hikes each in 2023 and 2024, hitting 1.8% by the end of 2024, with the long-run rate at 2.5%. The futures market is projecting the policy rate to hit 1.4% by the end of 2023. Overall, the risk is for the Fed to be more aggressive than these forecasts. Nonetheless, policy rates could remain below headline inflation for an extended period, intensifying the search for income.

The Fed’s forecast suggests the first hike could come as soon as 2022
EXHIBIT 7: UNITED STATES: MONETARY POLICY

Source: Bloomberg Finance L.P., FactSet, U.S. Federal Reserve, J.P. Morgan Asset Management.
Market expectations are the federal funds rates priced into the Fed Fund futures market as of 29/11/21. Federal Reserve projections shown are the median estimates of Federal Open Market Committee (FOMC) participants.
Guide to the Markets – Asia. Data reflect most recently available as of 29/11/21.

9.  What are the likely drivers of corporate earnings in the wake of higher costs?

Equity markets can exhibit volatility as sentiment swings and investors contemplate the economic outlook. But broadly, equity markets tend to follow earnings and, more importantly, earnings expectations.

For the first three quarters of 2021, U.S. earnings have beaten analyst expectations. Margins have expanded as demand recovered and companies were also able to control costs. Protecting profit margins is critical since for S&P 500 earnings it is difficult to achieve positive earnings growth without positive contribution from profit margins. Companies have had more pricing power given the strength in demand and the shortage in supply of many products, enabling them to increase prices as input costs rose.

However, high input costs, rising wages, the prospects for higher taxes in the U.S. and the ability for companies to continue to pass on these costs will challenge margins and corporate profitability. Another trend during this recovery is that companies have sought to increase productivity through capital investment, perhaps in response to the difficulties in attracting workers. A combination of lowering, or limiting, rising costs and increasing productivity could help support corporate margins in 2022.

When considering the aggregate outlook for earnings, the distinction needs to be made between sector weight based on market capitalization and based on earnings. The biggest sector by size may not be the biggest by earnings. For developed market equites, technology was the largest sector by market capitalization in 2020 at 22%, but a smaller 18% based on earnings. For that same year, financials was the largest by earnings at 20%, but represented only 13% of the index based on market capitalization. This is perhaps best considered through the lens of size and style biases in equity performance.

Style rotation will be less influential in equity allocation in 2022 as both value (e.g. financials) and growth (e.g. technology) can perform as bond yields rise and more developed markets shift in the mid-cycle economic environment. However, those sectors more tuned in to the economic recovery are likely to show strength in earnings.

Earnings growth has likely reached its peak for this cycle.

Analyst expectations have started to normalize as earnings revision ratios roll over for many developed market equities. However, while global earnings growth will likely slow in 2022 from an elevated pace, the level of absolute earnings should continue to trend higher in response to the ongoing economic expansion and revenue growth, which contributes a large share of overall earnings growth.

While it is harder to grow earnings from a high level and margins will face increasing pressures, equity markets should still deliver positive earnings growth.

Earnings growth in 2022 is expected to be near, or even above, historical averages
EXHIBIT 9: CONSENSUS ESTIMATES FOR GLOBAL EARNINGS PER SHARE GROWTH

Source: IBES, MSCI, Standard & Poor's, Refinitiv Datastream, J.P. Morgan Asset Management. Consensus estimates are calendar year estimates from IBES. Past performance is not a reliable indicator of current and future results. Data reflect most recently available as of 15/11/21.

11.  What policy shifts can we expect as governments tackle climate change?

The recent 26^th UN Climate Change Conference of the Parties (COP26) highlighted countries’ commitments to tackle climate change. Pledges and declarations on deforestation and methane emissions reduction were announced, while various Asian economies used this opportunity to publicize their own initiatives to raise targets for reducing greenhouse gas (GHG) emissions.

Ahead of the COP26 meeting, China’s State Council released its “Action Plan for Carbon Emissions Peaking before 2030” and reiterated its three main climate targets for 2025:

1. increasing China’s non-fossil energy consumption share;
2. reducing energy intensity; and
3. reducing carbon emissions intensity.

India also announced plans to target net-zero emissions in 2070. In addition, India raised its goal of reducing GHG emissions per unit of GDP by 2030, from a cut of 33-35% previously to a reduction of 45%. Pledges from China and India are key as they are respectively ranked as the world’s largest and fourth-largest emitter of GHG, considering the size of their populations and the scale of industrial activities.

Looking ahead, we could see a further acceleration in government spending, likely in the form of green infrastructure spending or an increase in green bond issuance. There could also be further measures aimed at incentivizing private capital to drive the change. Using regulatory levers to pressure large investors to tilt portfolios toward climate-friendly strategies may be one way to achieve this outcome. Another solution is for governments to co-invest alongside the private sector so that initiatives that could be too risky for the private sector to invest alone can still access the financing they require.

One example is the PBoC’s recent introduction of a new, targeted instrument to support decarbonization. Under this scheme, nationwide financial institutions will first provide loans to targeted sectors at interest rates around loan prime rate (LPR), e.g. current 1-year LPR is 3.85%. The PBoC will then provide funding support at an interest rate of 1.75% in the amount of 60% of qualified loans. This is in line with China’s targeted monetary policy support to promote economic restructuring related to green development.

Clean energy, environmental protection, energy efficiency and conservation, as well as carbon emissions reduction technologies and related infrastructures, are all expected to receive policy support. In China’s context, this could create new opportunities for investors as the internet and real estate sectors navigate through regulatory changes. Meanwhile, fossil fuels, heavy industries and transportation could face rising costs due to the introduction of carbon taxes and other regulatory scrutiny.

Understandably, investors have high interest for those targeted beneficiary sectors, and some institutional investors have announced they are divesting from traditional energy companies that produce fossil fuels. However, in our view, when considering the investment implications from climate change, investors should not apply the “one size fits all” judgement to distinguish between “new” energy versus “traditional” energy sectors.

We believe that active management continues to be critical in selecting the companies that can thrive in this area. For example, within the “new” energy sector, according to the International Renewable Energy Agency, between 2010 and 2020, the average unit cost of electricity generated by solar photovoltaic power has declined by 85%. This is clearly good news for users, but the drop in the price of equipment and power could be a challenge for some solar power panel manufacturers that are less competitive and face higher production cost.

In contrast, within the “traditional” energy sector, some international oil companies have been investing in renewable energy to diversify their business, and their transition could be an investment opportunity. Hence, company research is essential to make a rational investment decision when considering the investment implications from climate change.

The heightened interest in renewables, energy conservation and clean energy will likely drive further development in environmental, social and corporate governance considerations
EXHIBIT 11: EMISSIONS TARGETS AND GLOBAL ENERGY MIX

Source: J.P. Morgan Asset Management; (Left) Climate Action Tracker; (Right) BP Energy Outlook 2020. Forecast is based on BP’s scenario for global net-zero emissions by 2050.
Guide to the Markets – Asia. Data reflect most recently available as of 29/11/21.

0903c02a82a7d3a6

GLOBAL MARKET INSIGHTS STRATEGY TEAM