Where will the markets and the economy go in 2022?

If you make the mistake of looking back too much, you aren’t focused enough on the road in front of you.

– Brad Paisley

Many of us have fond memories of the family piling into the car and embarking on a road trip to a desired destination. These memories have likely become fonder after our experiences over the past two years. Often, the journey would be temporarily sidetracked by pit stops, some that were expected (stopping for gas, grabbing food, etc.) or unexpected (a small bladder, a speed trap, etc.). Yet, despite these short-term setbacks, we would inevitably reach our destination and the roadblocks experienced along the way were forgotten.

We envision the investment landscape for 2022 to be like that of a road trip. As we’ll outline, when we assess the growth and inflationary environment, we believe the landscape in 2022 will provide a good backdrop for global markets. However, the ride will have many pit stops along the way, impacting sentiment towards risk assets, such as:

fear of a policy mistake by global central banks
impact of COVID-19 variants on growth (at the time of writing, it’s the Omicron variant)
fear of inflation affecting consumption in a material way
U.S. mid-term elections
geopolitical risk.

If we experience any setbacks along the way, we believe that investors are likely to be rewarded if they maintain an optimistic view of the road ahead. Here’s how we expect the trip to go.

Growth is likely past peak but remains resilient

Global growth and earnings likely peaked during the summer of 2021. Despite headwinds posed by supply chain disruptions and inflation, the backdrop remains positive for global growth and earnings.

The Markit Purchasing Managers Indices (PMIs) provide advance insight into the private-sector economy by tracking variables such as output, new orders, employment, and prices across key sectors. A reading above 50 indicates that the manufacturing output is growing while a reading less than 50 signals that it’s contracting. Said differently, green is good, yellow is neutral, and red is bad.

Although economic activity is likely slowing and will face continued challenges including supply chain disruptions, overall, the global manufacturing environment remains in a resilient position. As we finished 2021, companies forecast (on average) that production will be higher one year from now, with the overall degree of confidence rising to a five-month high. Alongside optimism bred by the current upturn, manufacturers also expected several headwinds (including disruptions caused by supply chain stresses and COVID) to lessen during the coming year. Historically, a strong manufacturing environment provides a healthy backdrop for earnings.

This table shows the monthly Markit Purchasing Managers Indices from November 2019 to November 2021. A reading above 50 indicates that manufacturing output is growing; below 50 signals it’s contracting.

A metric we follow closely that supports our positive view is the U.S. Conference Board’s Composite Index of Leading Economic Indicators (LEI). The Index consists of 10 economic components whose changes tend to precede changes in the overall economy, including average weekly manufacturing hours, number of new building permits, and consumer sentiment, to name a few.

As of November, the LEI registered 9.8. Excluding the recent self-induced recession caused by the pandemic, since 1970, a recession and market peak occurred six months, on average, after the LEI became negative. At the current level and historical pace in which it takes the LEI to trend toward zero during the mid-cycle, it would suggest that the U.S. economy is in a stable position going into 2022.

Conference Board's Composite Index of Leading Economic Indicators
1960 – current

Here’s a chart that shows the U.S. Conference Board’s Composite Index of Leading Indicators, from 1960 to October 2021.

Source: Manulife Investment Management, Bloomberg, as of October 31, 2021

Inflation — enduring but softer

The Capital Markets Strategy (CMS) inflation model helps us forecast U.S. inflation measured by the Consumer Price Index (CPI). We use U.S. owner’s equivalent rent (OER), the U.S. Dollar Index (DXY), oil measured by West Texas Intermediate (WTI), and U.S. wages measured by the Atlanta Fed Wage Growth Tracker.

For our forecasts, we made these assumptions:

owner’s equivalent rent – upward pressure remains, which will see OER rise through 2022 towards 4 percent
U.S. Dollar Index – recent strength in the DXY reverses and trends back down towards 93
West Texas Intermediate – average of US$80/bbl is maintained for the next year
wages – trend higher towards six per cent as upward wage pressure remains.

Our inflation model suggests CPI will trend lower from current levels of 6.8 percent but will likely remain above three per cent through the third quarter of 2022. Inflation will remain a concern throughout 2022 but receive nowhere near the level of attention it’s receiving today.