Outlook 2022: Bridge to a new dawn

The Perspectives podcast

 

Outlook 2022: Bridge to a new dawn

 

Hosted by:

Chris Hyzy

Chief Investment Officer,

Merrill and Bank of America Private Bank

 

Featuring:

Ethan Harris

Head of Global Economics,

BofA Global Research

 

Savita Subramanian

Head of U.S. Equity & Quantitative Strategy

& Head of ESG Research,

BofA Global Research

 

Niladri (Neel) Mukherjee

Head of Portfolio Strategy for the Chief Investment Office

Merrill and Bank of America Private Bank

 

Jeremy Siegel

Senior Investment Strategy Advisor, WisdomTree

Emeritus Professor Finance, The Wharton School

 

 

 

Please see important information at the end of this program.

 

Chris Hyzy:

Hello and welcome to this edition of the Perspectives podcast.  I’m Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank.

On this episode, we’re bringing you key highlights from our year ahead webcast, “Outlook 2022: Dawn of a breakout era.”  In it, I speak with some of the best minds in the business about what the coming year could bring for the economy, the markets and other issues that are top of mind with investors. 

 

We cover everything from inflation and interest rates to which asset classes and sectors could offer the most promising growth opportunities in the current market environment.  And we discuss how investors can make sense of the many changes we’ve been experiencing.

 

Plus, I speak with legendary long-term investor Professor Jeremy Siegel about the biggest challenges and opportunities for investors in the coming year and beyond. 

 

I hope you come away with some useful ideas and insights from these conversations. 

 

With that, let’s start with my talk with Ethan Harris, head of Global Economics for BofA Global Research. 

 

 

Chris Hyzy:

Ethan, thank you for joining me today.

 

Ethan Harris:

Thank you.

 

Chris Hyzy:

2020, 2021, some would say extraordinary years as it relates to not just the pandemic, but in terms of the level of growth. Where are we headed in 2022, overall from a nominal growth perspective and your overall outlook as it relates to the economy, both the U.S. and globally?

 

Ethan Harris:

So we're going into another good year of recovery. I mean, the economy still has a ways to go before we get back to full employment. We should have GDP growth for the U.S. of around 4% and most sectors will remain strong.

 

We have a strong housing market. We have a strong consumer, business investment is picking up. So it's another year of recovery in the U.S. and to a lesser extent globally.  We think the global economy will also grow almost 4%. So it's going to be another solid year.

 

Chris Hyzy:

Give us the view on inflation, how to read it.  Differences today, perhaps versus what we've come to know, and the scary part of the late seventies, early eighties and what people should be really paying attention to as it relates to inflation overall.

 

Ethan Harris:

I think it's important to take a little bit from both those histories. The 1970s inflation was awful. I don't expect anything close to that. On the other hand, we've had a few decades of very benign inflation; that doesn't seem likely either.

 

I think what's going on right now is you've had both monetary and fiscal authorities decide, “We are going to make sure we get back to a fully employed economy, more normal inflation environment as quickly as possible.” The downside of all that is in the short run, we’re getting a lot of supply side problems where the strong demand is bumping up into constraints on availability of goods and services.

 

So there's both a good side to this kind of exceptional growth we've seen in the U.S. and the bad side is that we're going to get some inflation coming out of this.

 

Chris Hyzy:

Let's talk about the job market. Let's talk about employment overall. Are there structural changes going on because of the pandemic?  Is this something that was building beforehand?  Take us through your outlook overall on the jobs market, the employment angle to this economy between now and the end of ’22.

 

Ethan Harris:

One reason it's really hard to get back to where we were a couple of years ago in the job market is that there are some unfavorable trends. So the population is aging. Population growth is concentrated in people above 65 who tend to not be in the labor market. And so there's already some downward pressure on the availability of workers before the crisis.

 

And what the crisis has done is it's gotten a lot of people rethinking their priorities. So you have people taking early retirement. You have two-earner couples deciding that one of them can stay home and watch the kids. It's been an amazing period to kind of think about what your priorities are in life and it's having an economic impact.

 

So we don't see the economy ever quite getting back to that same level of employment that we would have been on absent the crisis. We think that we're going to run up into the limits of the job market much quicker. And in fact, we're already seeing elements of that today.

 

Chris Hyzy:

Now, for those of us who are up and down the highway, either in New Jersey or out in the west coast, what's going on in the supply chain world? Take us through your thoughts there. Is it easing? Is it something that's going to be with us for a while?

 

Ethan Harris:

Well, it's a little of both. I mean, like all economists, I speak with two hands, right? So what's going on is a broad-based disruption to capacity. So a lot of it has to do with COVID. Many of the sectors that are critical to supply chains have labor shortages, whether you're talking about truckers, people working at the ports, or if you're looking at manufacturing centers in Asia that have been shut down due to COVID waves. So there are problems at every link in the chain. 

 

The other issue going on here is a lack of investment in the supply chain. And that's partly lack of public infrastructure, partly because businesses didn't expect to see this kind of growth. So the capacity is not there. And then the final problem is that people have shifted their spending towards goods and away from services. So that means the pipeline of goods is clogged by very high demand.

 

Now this should unclog to some degree in the next year, but there's an element of this that sits with us for a while. And it's one of the reasons why some of this inflation stays with us, because we're just not going to ever quite get back to the same kind of ease of transport that we had before.

 

Chris Hyzy:

What do you think the overall level of the latest bills coming out of Washington could have on the overall economy, speaking of infrastructure, speaking of spending bills, etcetera.  What’s your latest thinking there?

 

Ethan Harris:

We had big tax cuts and spending increases for an economy at full employment back in 2018. And in the case of the Biden policies, we don't have the tax cuts, but we've got much bigger spending increases. And it seems to me that along the way, there should have been some trimming.

 

Now that doesn't mean there isn't some good stuff out there. I mean, there's definitely a desperate need for infrastructure. The U.S. is kind of behind the curve globally in terms of social infrastructure, so there's some good programs in there.

 

The problem is that we're paying for almost all of it with budget deficits, particularly in the early years of this new spending. So it's adding a little bit more heat to the economy that's already hot. And so there's a part of the overheating problem that I talked about is budgets.

 

Chris Hyzy:

Ethan, I want to thank you for joining me today.

 

Ethan Harris:

Thank you.

 

Chris Hyzy:

We turn now to my discussion on the markets, with Savita Subramanian, head of U.S. Equity & Quantitative Strategy and head of ESG Research for BofA Global Research; and Neel Mukherjee, head of Portfolio Strategy for the Chief Investment Office for Merrill and Bank of America Private Bank.

 

Chris Hyzy:

Savita, some would say that 2021 on back of 2020, were two of the greatest years in terms of equity returns that many investors, at least in certain cohorts, have experienced.  Take us through your outlook for 2022, with the fact that the Fed potentially could be going into a new regime?

 

Savita Subramanian:

Yeah, 2022 is going to be an interesting year. And I think it's going to be a tougher year than the last couple of years or even the last decade, where we've enjoyed pretty spectacular equity market returns.

 

I do think that stocks are going to be a much better place to be than a lot of other asset classes. Because think about it, stocks basically offer you protection against inflation. That's really the theme that we've been espousing is look for companies that can benefit from an inflation cycle, from an economic cycle. 

 

Maybe not the entire S&P 500 or even a large proportion of it is as well poised for this. But we do think that small caps and other areas of the market are likely to do really well over the next 12 months.

 

Chris Hyzy:

What do you see as the big drivers or the underlying anchor to the equity market for 2022?

 

Savita Subramanian:

Corporate America has done a great job with margin management. And I think what was really surprising this year is that we saw record margins for the S&P 500, despite the fact that cost pressure was off the charts. I mean, we had oil essentially double off the bottom, we had monstrous labor inflation.

 

But companies managed to either pass those costs along through prices to the consumer or essentially just get really efficient in terms of managing their costs. As long as margins don't compress too aggressively we think that this earnings, this positive earnings power can continue.

 

Chris Hyzy:

Neel, given what Savita was talking about, the U.S. outlook, this point in time in the business cycle, you would think that non-U.S. investments, particularly the equity markets relative to the U.S., would be outperforming. What gives you pause or what gives you an opportunity - U.S. relative to the rest of the world?

 

Neel Mukherjee:

Well, Chris, you're absolutely right. If you look at valuations, international equities are much more attractive in terms of valuation, but they have continued to underperform U.S. equities. And the reason for that is that fiscal stimulus has been more here in the U.S., earnings growth has been much better in U.S.; the economic recovery coming out of the great financial crisis has been much, much better here.

 

Now, as we go through 2022, it really depends on how COVID shapes up. If the pandemic starts to start to go down and if you think that emerging markets will play catch up, European economies will pay catch up, then international equities can have a little bit of a tailwind, if you will.

 

But right now, I think it's much, much more appropriate to stay U.S. equities first, and then look at Europe, Japan and then emerging markets.

 

Chris Hyzy:

Savita, you've done a lot of work around compounded returns and dividend growth and higher quality. Can you take us through that a little bit and your thoughts on that?

 

Savita Subramanian:

Absolutely. One of the tenets of our outlook for the next 12 months or longer is the idea that we really need to start thinking about our portfolios from a total return perspective.  So never ignore the dividend is our, is our mantra.

 

And here's where I think it gets interesting. So if you look at earnings growth over the last couple of years, it's been tremendous. I mean, we had 50% earnings growth last year, but dividend growth lagged earnings growth demonstrably.

 

And I think what we see over the next couple of years is companies catching up and raising their dividends more aggressively. The payout ratio of the S&P 500 right now is super low. And it can, we think that it can only go higher from here.

 

Chris Hyzy:

That's a great segue into sector outlook. Savita, what about sectors, your top two or three from your standpoint for 2022?

 

Savita Subramanian:

I think it's going to be a year where you want to be selective. You want to look for free cash flow generation and quality.  But you also want to look for companies that are tethered to a U.S. recovery, a continued recovery in the economy.

 

The sectors we like are financials, energy and healthcare. Healthcare literally saved the world in 2020 and yet it has lagged the S&P 500 for a couple of years.  I think healthcare is a sector where you can get secular growth at a much more reasonable price than some of these high-flying tech companies.

 

Chris Hyzy:

That brings us to that domestic equation again, which is small caps generally versus large caps. Neel, what are the thoughts on the size within the market cap?

 

Neel Mukherjee:

We actually put more cyclicality into our asset allocation models. So we went further overweight in small-cap equities. We went further overweight in value-oriented investments. And from a sector perspective, it's those cyclical areas of the market like financials, maybe industrials, materials even, which can get benefit from the infrastructure package as well. Those are the ones that will benefit going forward.

 

Energy is also one of the sectors, which I think is under-owned. And if the economy keeps opening up next year, the demand for energy will go up and that will put upward pressure on energy as a sector as well.

 

Chris Hyzy:

So 2022, we're calling it the dawn of a new era. But let's think about post ‘22. Give us your final thoughts on what's most important over the long haul as it relates to the market.

 

Savita Subramanian:

I think what's important is patience, avoiding panic selling or buying. And really looking for opportunities and extending your time horizon.

 

So where we see the best opportunities right now are in higher-quality stocks. We see a lot of opportunities within small caps, which could be at the point of resuming leadership for a multi-year period. So I think these are the types of aspects that we look for and that we recommend individual investors really capitalize on. 

 

Chris Hyzy:

Excellent. Neel?

 

Neel Mukherjee:

Well Chris, I would say that financial markets are inherently complex. They have always been complex, but especially in the last couple of years, given the unprecedented nature of the pandemic. So I would say that this is an environment where an investor has to take account and realize the risks they are taking. They have to be much more disciplined in their investment process.  

 

And that's where they have to have a trusted advisor who knows them well, starts with their goal, creates a long-term portfolio, sources the best manager and then rebalances appropriately. That's the winning combination in this new environment that we're going into.

 

Chris Hyzy:

Well, that's a great place to end.  Savita, Neel. I want to thank you for joining me today.

 

Finally, let’s go to my conversation with my special guest, Professor Jeremy Siegel, senior investment strategy advisor with Wisdom Tree and Emeritus Professor of Finance at The Wharton School.

 

Chris Hyzy:   

Professor Siegel, such a pleasure, always great to have you. You could argue that the last two years were five years in two, given everything that we've gone through and are still going through.

 

Jeremy Siegel:        

Right.

 

Chris Hyzy:   

Let's just reset now for a few minutes and just discuss, what are the biggest challenges and what are also some of the bigger opportunities that you see as we sit here, in late ‘21?

 

Jeremy Siegel:

Well, I think the biggest challenge is very definitely the Fed preventing inflation from getting worse. And you know, Chris, I've been saying this for a long time, I said it way back in 2020;

 

Chris Hyzy:

Over a year ago.

 

Jeremy Siegel:

That the monetary stimulus was excessive. The fiscal stimulus was excessive. I think the Fed is beginning to wake up to these realities now. And I think that the battling of inflation in 2022 will be the major macro-economic challenge.

 

Chris Hyzy:   

The Fed hikes two or three times, which is generally the consensus belief right now. Can corporate America still produce enough profits, enough cash flow to create an upward trending equity market?

 

Jeremy Siegel:        

Yeah, absolutely. Don't forget, when we speak of two or three hikes, we generally think of a hike as 25 basis points. I mean, two or three or four brings us up to 1%. It's hard for us older folk who remember rates being normal at four and five to think of 1% as being particularly restrictive for corporations.

 

It's still going to be below the recorded rates of inflation, which actually means that it's still going to be a negative real cost for corporations to borrow. So honestly, a few hikes is not going to put a crimp, in my opinion, in profits.

 

I think the challenges are going to be for the risk market and equity markets, the Fed may have to go much more than three or four. What does that mean for valuation?

 

So, I think it could be a strong economy with profits still being good, but valuation metrics changing in terms of, well, “what does that mean to how I have to price equities?”

Chris Hyzy:    

Yeah, so let's talk about valuation. There's so many different ways to value equities, let alone any asset class. From all of the work that you've done over many, many decades, how do you see this valuation argument right now in terms of whether, too elevated or just right? And in the context of a market that is expecting yields to rise?

Jeremy Siegel:        

I do not think the stock market is at all overvalued, taken as a whole. There's always some stocks as we know that are overvalued.  Right now the market is selling for about 22 times next 12 months S&P projected earnings, which still could be too low. My feeling is that they're probably too low 12 months forward, even with the rates hikes that I think the Fed is going to have to engineer. 

 

But in an interest rate environment where the Fed is going to have to be more aggressively tightening, I think there'll be a little bit of bumps along the way. I don't call them taper tantrums. I call them taper tremors. 

Chris Hyzy:   

So, in that backdrop, what's your view on various asset classes, small relative to large in terms of market capitalization, potential sector opportunities? How are you thinking about that for the full year of ‘22?

Jeremy Siegel:        

We all know of the so-called Fang stocks. If the Fed has to be more aggressive, the way I believe it is, that will affect technology stocks more than those stocks with what we call shorter duration. Call them the value stocks, if you will. The ones that have really quite underperformed for so many years.

 

I think that investors seeing those interest rates will rise will want those, particularly those that give dividends. Because we've done research as many others, that in the long run, if you want inflation protection on streams of income that are positive, dividend paying stocks are really the only long-term solution to that.

 

Chris Hyzy:  

Final question for you, long term. You are known as, I was going to say, the father of long-term investing.

 

Jeremy Siegel:        

Thank you.

 

Chris Hyzy:   

What's most important over the long haul when you just step back and think about investing and the equity markets in general?

 

Jeremy Siegel:        

Well, in general, don't hitch to just one or two wagons, because that's always going to change. Don't panic when there's all these situations that cause so much anxiety.  It's to stay the course. Diversify; don't put all your eggs in one basket or one set of baskets.  I think you've got to be broad based.

 

One of the strongest premiums that anyone has found over all of history, and I've done over 200 years, has been what's called that equity premium. That better return that you get in stocks over all other fixed income assets, even real estate assets. And that's what you should keep in mind.

Chris Hyzy:    

Professor Siegel, what a great place to end. Thanks so much again for joining us.

Jeremy Siegel:        

Thank you for having me, Chris.

Chris Hyzy:    

And thank you all for tuning into this Outlook 2022 edition of the Perspectives podcast. 

 

Here are a few final thoughts to keep in mind as you plan for the year ahead.

 

First, be sure you’re well diversified within and across asset classes, particularly in years like 2022, in our opinion, which could be slightly more volatile.   

 

Second, make a plan to review your asset allocation regularly and rebalance your portfolio as needed.  Also consider using any pullbacks in the equity markets to add to areas you may be underexposed to, including the more cyclical and higher quality areas.

 

Finally, have a consistent and disciplined investment process and maintain a clear focus on your long-term financial goals.

 

Thanks again for listening and we wish you a safe, happy and healthy year to come.

 

 

 

IMPORTANT DISCLOSURES

 

This podcast was recorded on November 30, 2021.

 

Jeremy Siegel, WisdomTree and The Wharton School are not affiliated with Bank of America Corporation.

 

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