Generali Investments, a giant with assets under administration of 577 billion euros, which with its multi-boutique platform brings together the main investment companies of the Generali Group, presented its 2022 outlook on the prospects and trends of the financial markets in 2022. According to economists economic recovery has solid fundamentals, notably consumer spending and investments. From the lows of March 2020, a global portfolio made up of 60% equities and 40% bonds has generated a return of almost 40%. However, the cautious removal of political support and high valuations will drastically reduce future returns from beta. The benefits of diversification are also set to diminish as economic policy normalizes. Volatility (changes in prices) will be significantly higher in 2022 than in 2021, as central banks oscillate between fighting inflation and controlling the conditions of financial equilibrium.
How to invest in 2022: stocks still rising
We expect equities to still offer positive returns in 2022, but in a more contained and volatile way. There is therefore still life in equities, given the low expectations of the consensus forecasts on earnings; we see earnings increase of around 10% on both sides of the Atlantic, with the possibility of an even better performance. The recovery should still support positive returns, albeit below 2021. Valuations are not cheap, with US and Euro Zone 12-month Price Earning ratios around 21 and 15 respectively, but they are when compared to fixed income. and real returns. The gap in PE between Europe and the US is wide and has reached new heights with Omicron. We have a slight preference for European equities, which also coincides with our Value judgment (at a discount to their book value), which should benefit from the increase in bond yields.
Bonds: beware of inflation risk
The most important financial variable to observe remains that of long-term real rates, which represent an anchor for the valuations of all asset classes, reads the report just published. While central banks pledge to tackle inflation and make sure financial conditions still support the recovery, rising bond volatility is the main source of market volatility. It is not just the bond yields that matter, but also their composition. Nominal yields rose much less than inflation expectations in 2021, while real yields continued to decline.
Bonds, yields moderately up: corporate bonds are interesting
We expect the self-correction mechanism (debt sustainability, financial and economic dependence on long-term low real yields) contain the rise in bond yields in 2022. Our view on corporate bonds is rather positive. The November 2021 spread widening was a reminder of the more difficult times ahead, yet solid fundamentals (cash positions, rating migration, low default rates, residual ECB support) and the ongoing recovery should contain spreads ensure additional returns over risk-free bonds, such as government bonds. We expect the implementation of the ECB’s greening plan to have a positive impact on the performance of the sector and stocks.
Emerging markets, slightly recovering
The Fed’s upcoming hikes and further repricing of the political path for now support the US Dollar, although it is already starting to show high valuations relative to economic fundamentals. Emerging markets in general underperformed during the pandemic in currencies, equities and fixed income; we see more promising outlook in 2022, but Fed peaks and dollar strength in the near term will limit yields.
Italian GDP returns to pre-pandemic levels
The economy has rebounded sharply and GDP is expected to rise 6.3% in 2021, returning to pre-Covid level in early 2022. The hugely successful vaccination campaign allowed for the rapid reopening of the service sector, while industrial production proved quite resilient to the bottlenecks of the global supply chain. The key driver for growth in 2022 (which we see just above 4%) will be the successful implementation of the Recovery Plan, which should stimulate public investments and facilitate private ones. However, political uncertainty will return to the fore in the first weeks of the new year, as the election of the new President of the Republic will test the strength of the heterogeneous coalition that supports the Draghi government and could slow its ambitious reform program. Early elections remain a risk, to which we give a low probability.
What the markets fear: here are the three main risks
The risk posed by a dangerous variant remains, as vaccines have not blocked the spread of the virus, but have successfully reduced the risk of severe cases. New drugs are also on the way and we assume that social life and economic activity will slowly normalize in 2022. What could go wrong then in 2022? The three main risks lie in a political error that could cause financial chaos, a disorderly energy transition capable of generating a spike in the prices of selected raw materials and a complex variant that escapes vaccine protection. These risks will require an agile approach in 2022: tactical asset allocation, risk hedging and return generation (alpha) strategies will become increasingly important.