Equities are on track to end the year with a strong gain. With the notable exception of Asia's emerging markets, all major indices are set to deliver total returns well above the past decades' norms. The major developed markets have booked more than three times their 20-year annualized return thus far this year, led by Europe (which returned four times its 20-year annual norm) and followed by Japan and the US, with about three times each. Such strong deviations from the norm mandate a more cautious approach for the coming year.
Expect choppier market action going forward
Over the past year, investors have (rightly) been relatively sanguine about the outlook – but that too is liable to change. In fact, investors are increasingly aware that equity market volatility will probably rise significantly from current levels, after plummeting since the initial COVID-19 shock in early 2020. That outlook is also consistent with broader macroeconomic trends: The global economy is just a year short of closing the gross domestic product (GDP) gap to the pre-pandemic trend. At the current pace, the macro environment will thus start to look increasingly “mid to late cycle” as 2022 progresses. That kind of environment implies elevated macro and market volatility, strong but slowing growth, and inflation rates above central bank targets (but below current levels).
That said, we should restate that the factors favoring equities over most other asset classes in the coming year remain very much in place: monetary and fiscal policy is still clearly supportive, earnings growth is and will remain robust (the current consensus is too cautious, in our view), and market valuations on aggregate are certainly not extreme. In fact, thanks to stronger than expected corporate profit numbers, the forward price earnings ratio for the MSCI World All-Countries Index has declined from a peak value of 20.4 last September to about 18.2 at present. Lastly, the fact that expected volatility is already priced above average suggests that an uptick in actual volatility is unlikely to catch investors off guard – implying limited impact on stock markets.
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Note: The next edition of the LGT Beacon is scheduled for December 2021.