Economic and financial outlook 2022
Peter Vanden Houte
Senior economist ING
Investment Office ING
Inflation remains (too) high, while recession threatens. Central banks confuse financial markets: how to react?
Macroeconomic outlook: flirting with recession
Just as the negative impact of COVID-19 seemed to be fading, the global economy was hit by new shocks. Supply chains were again disrupted by the war in Ukraine and were further affected by China's draconian measures to combat the Omicron variant. On top of this, sanctions against Russia have tightened energy markets, putting upward pressure on prices. The euro area is particularly affected as it has seen the largest increase in energy prices over the past year. Such a rise in energy prices has almost always led to a recession in the past. Central banks are relying on consumers to tap into their savings to support the recovery, despite the decline in purchasing power. However, falling consumer confidence makes this highly unlikely. For the time being, some service sectors such as tourism are still doing well thanks to the reopening of the economy, but this recovery is likely to fade after the summer. The manufacturing industry is also benefiting from a full order book, given the orders that could not be delivered last year, but this recovery will probably be temporary. Finally, the most interest rate sensitive sectors, such as construction, are likely to feel the impact of a more restrictive monetary policy with a certain time lag.
Belgian growth remains around 2% in 2022, but risks weakening in 2023
The Chinese economy is already in recession due to successive lock-ups and the planned fiscal stimulus is unlikely to be sufficient to achieve the 5.5% growth target this year. The US is currently overheating. Growth will be close to 3.75% this year, but aggressive interest rate hikes will cause a sharp slowdown in 2023. The eurozone is likely to stagnate from the second half of the year, although the growth rate for 2022 will still be around 2% because of the favourable starting position, the so-called threshold effect. The Belgian economy is also expected to grow at around 2% this year for the same reason, but 2023 looks much weaker.
Inflation threatens to end the year above 5%
Inflation figures continue to surprise on the upside. The continued rise in oil and food prices, the war in Ukraine and the price increases in the service sector after the reopenings mean that the fall in inflation in the second half of the year will be limited. In addition, the energy transition and the decline in globalisation can be expected to continue to put upward pressure on consumer prices for some time. Although sluggish consumption reduces the scope for companies to raise prices - which could keep inflation in check - inflation is still expected to be above 5% at the end of 2022 in both the US and Europe.
Monetary brake firmly in place
As overheating in the US continues to fuel inflation, the US central bank has decided on a more aggressive monetary tightening. The key interest rate is expected to reach 3% by the end of the year. In Europe, there is no real overheating, but as persistently high inflation is also starting to raise inflation expectations, a tighter ECB monetary policy is now a certainty. By the end of the year, interest rates should already be 100 basis points higher than their current level. This means that, for the first time in seven years, European short-term market rates will be positive again.
Long-term interest rates have already risen sharply
Expectations of a rapid unwinding of monetary stimulus have already pushed up long-term rates sharply. Many rate hikes are now priced in, and long-term rates generally only start to fall again when central banks signal that the end of monetary tightening is near. And we are not there yet. The consequence of rising interest rates is that risk premiums in the bond market are also rising, which can already be seen in the widening interest rate differentials between the weaker eurozone countries and Germany. This could again raise questions about the stability of the euro area.
Financial perspectives: Caution in favour of value and defensive stocks
Fears of recession or stagflation have been the subject of debate for months. As central banks' efforts to curb rising prices raise fears of shrinking profit margins, global stock market capitalisation has fallen by almost EUR 13 trillion since the beginning of the year (-12%).
13 trillion since the beginning of the year (-12%). The decline in equities is mainly attributable to the fall in their valuations, which have been dragged down by the rise in bond yields. Their expected price/earnings ratio over the next 12 months is 20% lower than it was at the beginning of the year. So far, earnings do not seem to be a concern. Earnings growth forecasts have indeed risen by around 10% (in euros) since 1 January 2022.
But this does not take into account the fact that even if the economy merely experiences a "soft landing" - that is, a slowdown in activity that does not result in a recession - this could be enough to weigh on corporate profits. If their sales growth turns out to be lower than their production cost growth, their profits and profit margins, which remain historically high, are likely to weaken. In other words, it cannot be ruled out that investors in equities or corporate bonds may face more volatility.
Top credit quality bonds become attractive again
In this uncertain environment, investors should protect their portfolios by focusing on investment factors that favour low-duration stocks (not very sensitive to interest rate changes), stocks of companies capable of increasing their selling prices, offering high dividend yields, low volatility and less sensitivity to the economic cycle.
- When it comes to finding safe havens on the stock market, value stocks, which are undervalued relative to their fundamentals, should continue to perform better than growth stocks. These stocks, which are found in particular in the energy and financial sectors, are less penalised by rising inflation and interest rate expectations because of their lower duration. Since the beginning of the year, they have outperformed growth stocks by 20% (in euros)!
- Defensive" companies, such as utilities and healthcare, should also continue to perform well. Thanks to their lower sensitivity to economic conditions, their ability to pass on higher production costs in their sales prices, their high dividend yields and their low volatility, they have outperformed more cyclical stocks by almost 18% (in euros) since the beginning of the year.
- Commodities (+42% year-to-date), and the companies that produce them, still offer excellent protection against inflationary pressures.
- Finally, investors seeking protection against potential market turbulence may start to become less negative on investment grade bonds, as these offer a yield (3.2%), which is now higher than the dividend yield on equities (2.4%).
Plans for the future or a specific financial goal in mind?