2022 Outlook

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GAM and partner managers provide their outlook for 2022 for their respective asset classes. They cite energy transition, rising interest rates, the Asian emerging middle class, the strength of the European banking sector, demand / supply imbalance and of course the Omicron variant of Covid-19 as among the things to watch out for in the coming year.

22 December 2021

Niall Gallagher, Investment Director, European Equities

We think we are going into quite a different environment than we have been in for the last 15 years or so. In the last 15 years since the global financial crisis (GFC), we have seen an environment of quite low economic growth, very low inflation and falling bond yields. In that environment, which was also governed by an element of deleveraging and low physical investment, certain types of stocks did very well. Those stocks were essentially quality stocks; low volatility, persistent cash flow type companies, as well as growth companies, because in an environment of scarce growth, these were the types of businesses that did well and in an environment of falling bond yields, many stocks that were quality or growth were re-rated. We think, having come through the pandemic, we are heading into an environment where there is going to be a bit more inflation. There will be probably high levels of growth.

But we also think we are going into a super cycle for capital investment, which will be driven partly by governments wanting to invest more just to support economies. In addition, the transition to net zero is going to require significant amounts of capital investment across the whole range of industries, energy networks and also into areas like residential property. Over the last 18 months or two years we have gradually increased exposure towards some of these very strong structural growth trends.

The obvious concern is that the mutations of Covid-19 mean we are subject to repeated shutdowns. At times, some of the panic from governments has been damaging, but we think most companies will be well prepared, even if we do see something of a stop/start environment, with the exception perhaps of those in travel which may be impacted. While we think further Covid-19 related restrictions are the biggest risk, the other risk, which we think is not material, is we could have a more serious rise in inflation than policymakers recognise. We think central banks are behind the curve. What we are saying is quite different to the things central banks have been talking about. While we think we are well positioned for an environment of higher inflation, that environment could also be quite devastating for certain asset classes.

Paul McNamara, Investment Director, Emerging Markets Fixed Income

Our outlook for local Emerging Market (EM) debt remains broadly unchanged as we head into year-end. The asset class is under-owned, and if global growth remains firm into 2022, as we expect, it could benefit from the potential for positive total returns – something that could be rare in the fixed income space if Treasury yields rise (and prices fall) as the Federal Reserve (Fed) begins to taper and raise interest rates. We are seeing early signs of activity stabilising in China, and despite concerns about the Omicron variant of Covid-19, we believe severe lockdowns are unlikely, even in Europe. Should this continue, the US-centric global growth pattern and commensurate US dollar strength that has been such a feature of 2021 should wane, especially given a negative US fiscal impulse. We believe EM valuations are attractive, with a substantial yield cushion relative to developed markets and most currencies screening cheap – though, as Turkey has demonstrated, differentiation is key.

Swetha Ramachandran, Investment Manager, Luxury Equities

Luxury shares’ strong performance is supported by earnings upgrades that are continuing. Growth drivers are structural: the continued rise of the Asian emerging middle class, the influence of younger consumers, and digitisation – both to reduce capital intensity for the sector from servicing consumers at lower costs and to build new revenue streams in the metaverse. The connecting thread to these drivers is also the growing role of sustainability concerns in consumption behaviour: ‘buy less, buy better’ is the de facto motto of the luxury sector. We believe the market is underestimating the pricing power of the sector, which should fuel margin expansion well into 2022, against a sustained healthy demand backdrop in 2021. We expect ongoing trading momentum into year-end should likely prove to be a catalyst for continued outperformance of the sector, against a favourable macro backdrop.

Romain Miginiac, Fund Manager & Head of Research, Atlanticomnium

Going through Covid-19 has actually been a positive catalyst for subordinated debt, reflecting the resilience of the financial sector and the strength of fundamentals. Banks have navigated the crisis with very strong capital levels, with Common Equity Tier 1 (CET1) now at a record high of 15.8%; a GFC scenario would have been manageable without jeopardising Additional Tier 1 (AT1) coupons. Regulation has proved to be extremely supportive for bondholders, as banks had accumulated capital ahead of the Covid-19 crisis and excess capital increased during the crisis. While capital positions will decline slightly from record highs as banks have restarted paying dividends, the fact the European Central Bank (ECB) removed the cap on dividends was a vote of confidence for the resilience of the sector and as such positive, even for bondholders.

Valuations look attractive, particularly given the recent selloff. We think there is long-term upside potential; spreads are currently at around 340 bps compared to 270 bps pre-Covid-19 lows. Although new-style AT1s have fewer bondholder-friendly features (triggers, higher coupon risk etc), this is more than mitigated by the robust fundamentals of issuers.

Supply should also be a strong catalyst for 2022; it is likely to be the first year of net negative supply in the AT1 market (more redemptions than new issuance). Historically supply has been a headwind for AT1s given very large issuance to fill requirements of USD 30 billion or more in most years since 2014. On top of net negative supply in 2022, there is an acceleration of legacy bonds being taken out given the December 2021 grandfathering deadline, taking ‘real’ net supply into negative territory.

A holistic approach to subordinated debt investing is key for long-term investors, in our view. Although we do like bank AT1s, we think investors should focus on robust structures that currently offer better risk-adjusted value (core European issuers, bonds with low extension risk, shorter call dates). In the insurance sector, Restricted Tier 1s (RT1s) continue to offer attractive value, with similar spreads to AT1s with a more bondholder-friendly structure (lower coupon risk, no bail-in regime). Legacy bonds remain an attractive area in which to hunt for specific stories.

Read Romain’s 2022 outlook for subordinated debt of financials in more detail here.

Adrian Owens, Investment Director, Global Macro & Currency Fixed Income

While it is still unclear just how the Omicron variant of Covid-19 is likely to impact economic activity in the coming months, we feel confident in predicting that, however it plays out, it will not be helpful for inflation. If more restrictive measures are implemented by governments to tackle the virus, this will damage the supply side of the economy further and only exacerbate the current demand / supply imbalance. It is also likely to result in even slower withdrawal of central bank liquidity. If, on the other hand, Omicron does not have any meaningful impact on economic activity then we are back to the status quo of the major central banks remaining being behind the curve and failing to appreciate the full extent of the inflation pressures at work.

Tom Mansley, Investment Director, Asset Backed Fixed Income

The supply and demand factors that have produced the bull market in housing are likely to continue for some time. Therefore, we expect home prices to continue to rise, but at a slower pace going forward. Mortgage delinquency rates have dropped sharply since they spiked in the second quarter of 2020. We expect delinquencies, foreclosures and losses to continue to decline due to the low unemployment rate and the substantial amount of equity homeowners now have in their homes. Although credit spreads have recovered much of their loss from the large selloff in March 2020, they are not yet back to pre-Covid-19 levels in the non-agency Mortgage-Backed Securities (MBS) markets, so we still see good relative value in these markets versus other fixed income sectors.

Thomas Funk, Investment Director, Switzerland Equities

The economic system has enormous strength to rebalance in a dynamic process to a state of equilibrium. However, after a massive disruption it is often different to before the disruption, ie a new equilibrium is found with different conditions in the market. In the field of semiconductor production, for example, there is already talk of higher inventories in the future, since the costs of production stoppages are much higher than those of higher inventories. Production will also be increasingly internationalised and regionalised. Regardless of the exact further course of the Covid-19 pandemic, it is very likely that the value chains and companies will increasingly adapt to the situation. In past crises, it could be observed again and again how small contributions of individual market participants lead to a solution of the problems through the coordinative forces of a market-based economic order. This is likely to happen gradually in 2022. In this evolutionary process, agile, solution-orientated companies that know how to use new situations and opportunities will benefit.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is not a reliable indicator of future results or current or future trends.

Niall Gallagher

Investment Director

Paul McNamara

Investment Director

Swetha Ramachandran

Investment Manager

Romain Miginiac

Fund Manager & Head of Research at Atlanticomnium S.A.

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