Enormous fiscal stimulus, funded by monetary policy, and pandemic induced supply-side challenges pushed inflation to its highest level in nearly 40 years. This poses risk to cycle longevity and valuations, but good years are likely still ahead of inflation slows in 2022. Here are our 22 investment themes and views to watch for in 2022:
1. Continued growth in 2022: Growth is strong in this new expansion, but with uncertain inflation and interest rates ahead, which can ripple through currency, commodity and risk asset markets. Inflation should slow in 2022 as stimulus fades, more services return and goods production climbs. This cycle is two years old, perhaps going on seven; productivity and disinflation needed to rejuvenate.
2. A rapidly aging cycle? Given this uncertainty, we embrace diversification across style, regions and size and seek to enhance investment performance by positioning with thematic secular trends, such as: digitalization, ESG (environmental, social and governance), workforce productivity and health-care solutions for an aging U.S.
3. This cycle can be golden, if inflation slows: Based on DWS forecasts, U.S. real GDP/CPI (consumer price index) will approach the 1.6 golden ratio that marks past periods of prosperity and strong equity returns.
4. How high will the Fed go? Since 1982, the average hiking cycle was 240bp over 15 months, last cycle ended in 2019 was 225bp. We expect the Fed Funds rate to plateau at 1.5-2.0%. If greater, it likely boosts the dollar, hits commodity prices, cheapens imports, pressures global growth and boosts Bank profits. The Fed’s actions are likely incremental to avoid disruptions.
5. Interest rates should rise, but stay negative in real terms: We expect 10-year Treasury yields to rise to 2.0% in 2022 with long-term inflation expectations at about 2.5%. Thus, 10-year Treasury Inflation-Protected Securities (TIPS) yields stay negative at -0.5%, but up from -1.0% today. We watch 3-year yields for indication of a rate hike plateau, also 5-year yields and breakeven. We still prefer TIPS over Treasury bonds.
6. Treasury yield curve flatter: We estimate the neutral real Fed Funds rate to be 0%, or 2% nominally given the Fed’s 2% inflation target. If the Fed hikes higher, an inverted curve is likely.
7. Low interest rates due to high wealth, but debt and valuations suggest hikes will slow GDP/CPI.
8. Biggest inflation risk is excessive fiscal spending: Reducing the risk of stubbornly high inflation requires right-sized fiscal policy that is well targeted with clear return on spending goals.
9. Mid-term elections: Democrats face inflation-stained record. Republicans likely retake Senate.
10. A more virtual world: Constrained physical economy induces digital solutions and alternatives.
11. New economy infrastructure: 5G, semi fabs, bio labs, green energy, next-generation defense.
12. Car wars: The ‘20s will be the decade of electric cars; excitement now, fierce competition later.