Covid-19 will continue to impact the economy and markets

We entered 2021 with the prospect of new vaccines taming Covid-19 and that effort proved transformative in developed markets. The coronavirus persists, however, and its impact will continue to be felt in 2022 as the pandemic plays out. New therapies to prevent serious illness are very promising but expect a focus on Covid and a return to normal life to continue in 2022.

Gauging a company’s exposure to lingering Covid impacts – and lasting Covid changes – will be an important component of research in 2022. Another important Covid carry-over is that we expect cyclicals to outperform in the first half of the year, especially given expected ongoing economic reopening and above-average GDP growth.

Supply chain disruptions will start to improve – eventually

The pandemic was the proximate cause of supply chain disruption, shuttering manufacturing facilities globally. For industries with “just-in-time” inventory practices this was extremely challenging, as replenishing exhausted inventories proved nearly impossible, or at the very least very expensive. We expect elements of the supply chain to improve over the course of 2022, but there is still a significant backlog and wide variation among companies in their access to materials and success in passing costs on to consumers.

The seized gears of the supply chain caused many to speculate that the world would move manufacturing away from China or even onshore production. But the considerable cap ex required to drive that radical change seems unlikely. What is likely to change, however, is how much inventory companies decide to hold, and that means that focusing on inventory levels and pricing power as part of fundamental research takes on heightened importance. There will be clear winners and losers in this environment, and active positioning will set investors up for success, especially in the context of cyclical opportunities in the first half of the year.

Higher rates, lower valuations?

Historically, higher interest rates have correlated with lower equity valuations. Higher rates in 2022 could put equity multiples under pressure, which means it is important to know what you are paying for. For investors whose value exposure is below their strategic allocation, 2022 could be a good environment to increase that allocation. That said, cheap is not an investment thesis; in an environment of greater dispersion, understanding the fundamentals of a company relative to the price is essential.

Investing in the US versus elsewhere

Equities are expensive in most regions, but on a relative basis, valuation metrics are more attractive in Europe and emerging markets (EMs) than in the US (Figure 1). Headlines around China and inflationary pressures may cause some anxiety regarding EMs, but a strategic allocation still makes sense as long as it fits your risk tolerance.