With the end of 2021 rapidly approaching, asset managers are busy preparing their 2022 market outlook analyses, with many drawing the conclusion that the next year is likely to bring both challenges and significant opportunities for institutional investors.
According to new survey findings shared by Natixis Investment Managers, nearly half of institutional investors in the U.S. and globally expect economic growth to return to pre-COVID-19 levels in 2022. Despite the threat of supply chain disruptions and ongoing COVID-19 concerns, including those raised by the new Omicron variant of the virus, institutional investors see plenty of growth potential in a market they say is “driven and distorted by fiscal and monetary policies.”
According to the Natixis report—which surveyed 500 institutional investors who collectively manage $13.2 trillion in assets—the consensus among the majority of institutional investors around the world is that next year’s markets will likely see small-cap equities outperform large caps, while value stocks may outperform growth stocks and emerging markets could outperform developed markets. Perhaps no big surprise given recent economic developments, inflation ranks as institutional investors’ top portfolio risk concern in 2022. Despite this, a sizable majority of those surveyed (61%) think the current spike in inflation is temporary. But, in the United States, the majority believe that higher inflation is a more of a secular trend that will play out over time.
“Institutional investors are clearly telling us they expect the market to look very different next year than what it does today, and they are positioning their portfolios to withstand whatever is thrown at them,” says Liana Magner, Natixis Investment Managers executive vice president and head of retirement and institutional in the U.S. “While inflation poses a number of long-range economic issues, interest rate policy presents institutional teams with immediate investment challenges. The upside is an expansion of investment opportunities and emerging growth potential in a market ripe for active management.”
The Natixis survey shows 62% of institutional investors expect pent-up demand for big-ticket items to be a significant driver of growth in 2022, with 52% of institutional investors in the U.S. expecting consumers to spend more next year. Some 22% foresee high levels of “revenge spending” as people splurge after a long period of isolation and restrictions. Notably, the vast majority (85%) expect the majority of employers to move forward with a hybrid work model, pointing to a broad, but flexible, return to the office for many workers.
According to related market outlook commentary shared by William Davies, deputy global chief investment officer (CIO) at Columbia Threadneedle Investments, the global reopening trend and an enduring rebound in consumer demand have resulted in heightened cash flows among publicly traded companies, which have boosted corporate coffers and given many companies the tools to reduce leverage.
“We have seen good earnings recovery this year, a reflection of relatively strong balance sheet management by corporates, with stricter cost controls and strong discipline on dividends and share buybacks,” Davies explains. “But, given the supply chain bottlenecks and the persistence of inflation, it will be harder for companies to beat forecasts in 2022 in the way they have in 2021, at least in the short term. For companies, we anticipate next year will be a return to the familiar cycle of earnings disappointment as opposed to positive surprises.”
Davies’ overall view is that “2022 will be a year of change.”
“We have had an environment of fiscal and monetary stimulus for some time, and when taps are kept open investors do not mind how much governments and central banks spend or how big a national deficit is,” he suggests. “But change is coming, however unwanted it might be, and we face a world of economic repair in which markets and investors must consider the impact of reduced fiscal stimulus.”
Returning to the Natixis survey data, few institutional investors are making dramatic allocation changes heading into 2022. That said, most will make tactical moves that reflect the new realities of living and prospering in the COVID era and position portfolios for opportunistic and risk-adjusted returns. According to the survey, about half (48%) expect the spread between security returns, or dispersion, to widen next year, creating greater potential for active managers to outperform benchmarks.
Overall, 35% of institutions plan to decrease their exposure to U.S. equities, allocating more to emerging market, European and Asia-Pacific stocks. In response to the evolving interest rate environment, 68% of institutions say they will look at short-term bonds and exchange-traded funds (ETFs) to counter duration risk in their bond portfolios. Meanwhile, many are looking further afield for income, including 68% who say they are increasingly using alternative strategies over fixed income to generate yield.
In the year ahead, institutional investors expect higher volatility in stocks (75%), bonds (63%) and currencies (56%). Yet they continue to manage toward a long-term return assumption of 7%, on average, and with an eye on balancing present needs with future liabilities. Individual investors’ long-term return assumptions, however, are now 14.5%, or twice that of institutional investors and 174% more than the 5.3% returns financial professionals think is realistic.
For their part, Russell Investments’ strategists forecast 2022 as a year of moderation for economic growth, inflation and investment returns, and they believe the global economy is poised for another year of growth. Overall, the team’s 2022 outlook maintains a moderately positive medium-term view on global equities.
“After a year of rebound and recovery for global markets in 2021, we expect 2022 will be a year of moderation,” says Andrew Pease, global head of investment strategy at Russell Investments. “Developed economies have spare capacity, households are sitting on accumulated savings from the pandemic lockdown and central banks are planning to gradually remove accommodation. We expect above-trend growth in 2022, although slower than 2021.”
Identifying their three main uncertainties for 2022 as inflation durability, a slowdown in China and new COVID-19 variants, Russell Investments’ strategists continue to see the 2021 inflation spike as mostly transitory. But, they note, it could reach “uncomfortably high levels in early 2022” before declining as supply-side issues are resolved.
In terms of portfolio construction in the year ahead, Russell Investments’ asset-class preferences for 2022 favor non-U.S. equities over U.S. equities, while they expect emerging markets equities to remain under pressure from the economic slowdown in China as well as central bank tightening across other emerging markets economies to contain inflation pressures.
“Emerging markets equities could do well if there is significant China stimulus early in the year, the Fed stays on hold and the U.S. dollar weakens, but otherwise, they face headwinds heading into 2022,” Pease says.
Russell Investments believes real estate investment trusts (REITs) and global listed infrastructure should continue to benefit from the pandemic recovery. Commodities, which have been the best-performing asset class in 2021 amid strong demand and supply bottlenecks, will likely retain support from above-trend global demand.