In the markets, fundamentals may dominate in 2022

Morgan Stanley Research


Summary: Morgan Stanley strategists say the easy returns are over for US equities and Treasuries, but see value in European and Japanese stocks in 2022.

The current market cycle has been hot and fast. So much so, in fact, that investors are now confronting a very different dynamic for the year ahead—early-cycle timing, midcycle conditions, and late-cycle valuations, with exuberance to boot.

“As unprecedented fiscal and monetary policy support fades, fundamentals dominate,” says Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley Research.

While inflation will be at levels higher than many investors have seen before, Morgan Stanley economists believe prices will soon “peak then retreat” as supply chain pressures ease and prices for many commodities normalize. To that end, central banks likely won’t take drastic measures to raise rates and pump the brakes on growth. That said, investors have an almost Pavlovian response to any talk of tightening, which is one reason to approach US equities and Treasuries with caution.

Here are five highlights from the Morgan Stanley Research 2022 global investment outlook.

1. Time to lighten up on US stocks?

Strategists think the S&P 500® index may not be a star performer in 2022 and could decline 5%, while other developed markets could end the year higher.

The persistent price outperformance of US stocks for much of the last decade has been driven by superior and more durable earnings trends, but uncertainties are mounting around cost pressures, supply issues, policy uncertainty, and tax changes.

2. European and Japanese stocks are calling

In contrast to US equities, stock markets in Europe and Japan are more reasonably priced and geared toward growth.

In Japan, equities continue to deliver improving returns on equity, while economic stimulus, business reopenings, and strong global capex all suggest that Japan’s stock market could appreciate 12% next year.

Meanwhile, the MSCI Europe index has enjoyed its best period of relative outperformance in 20 years compared to the rest of the world,1 and that pattern may continue thanks to increased mergers and acquisitions, buyback activity, and changes in investor positioning since many global portfolios had been underexposed to the region.

According to Morgan Stanley Research combined earnings and valuation assumptions, European stocks could deliver an 8% price return and double-digit total return. The team’s top sector picks include autos, energy, and financials.

3. Stock selection could matter more than style and sector

Morgan Stanley strategists believe health care, financials, and secular technology companies may see upside in the year ahead. Consumer goods and cyclical technology stocks could lag as supply and demand dynamics settle into a more normal pattern.

Even so, relative to other points in this market cycle, there may be fewer opportunities for investors to take advantage of big swings in styles and sectors.

“In our view, the economic and political environment has been permanently altered from its pre-COVID days, although the changes are not necessarily due to the pandemic itself,” says Mike Wilson, Chief US Equity Strategist for Morgan Stanley Research. The eventual outcome should mean greater investment and productivity, but that could take years to play out. “That breeds higher uncertainty and dispersion, making stock picking more important than ever in the year ahead,” Wilson says.

Dispersion is high across sectors—stock selection will be key in 2022

Bar chart displaying the average annual dispersion year-to-date

Source: ClariFi, Morgan Stanley Research

4. Government bonds are all over the map

Central banks in developed markets responded to the COVID-19 pandemic with near-uniform interest policies and a deluge of liquidity.

In 2022, however, bond markets will need to make sense of differentiated policies. Some policies, such as in the UK and Canada, will likely be aimed at outright tightening financial conditions, while others may attempt to ease financial conditions further, albeit at a slower pace, or maintain accommodative financial conditions.

Morgan Stanley strategists expect the yield on the 10-year Treasury to move past 2% by the end of 2022.

5. In commodities, oil springs ahead

For the first time in a decade, commodities outperformed the S&P 500 in 2021, for a variety of reasons. Gold prices have been supported by stagflation concerns and the pushing out of rate hike expectations, while base metals have benefited from the combination of constrained supply and rising demand.

Looking ahead, metals may lose their luster as high real yields weigh on gold prices, while copper and zinc prices soften with better supply. Aluminum remains a top pick for strategists, who point to cyclical and structural factors.

Within commodities, oil may offer a good combination of valuations and fundamentals. The team believes oil could top $90 a barrel in 2022 as rising demand meets relatively spare capacity.

For more insights on the current environment and what may be in store for markets and the economy next year, check out the latest Thoughts on the Market episodes.

The source of this Morgan Stanley article, 2022 Global Strategy Outlook: Fundamentals Will Dominate, was originally published on December 14, 2021.

  1. Morgan Stanley Research, “2022 Global Strategy Outlook: The Training Wheels Come Off,” 11/14/21

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