2022 - Bouts of Volatility and Mean Reversion
- It is likely you will need to prepare for a more normal equity market in 2022
- Sector heatmap highlights longer term mean reversion
- Expensive growth companies feel the heat of higher rates
It is Likely You Will Need to Prepare for a More Normal Equity Market in 2022
The last few years have been so atypical you can be forgiven if you need a refresher on normal. Figure 1 below places the recent equity market returns against the 25 year average. In the last 3 years global equity market returns have averaged +18.4% per annum which is 3 times the average 6.1% return per annum experienced over the last 25 years. As Government and Central Bank pandemic policy settings begin to unwind investors should readjust their expectations for less bullish returns and a few bouts of volatility.
Sector Heatmap Highlights Longer Term Mean Reversion
In figure 2 below we highlight the divergent sector performance over the last 25 years as well as the recent extremes. Not surprisingly the technology and consumer discretionary sectors have generated the largest returns in the last 3 years. More importantly the heatmap shows that no sector remains positive consistently. Often a period of outperformance is followed by a period of underperformance and vice versa.
The heat map is a timely reminder to have a diversified portfolio and to take some profits after excessive windfall gains.
Expensive Growth Companies Feel the Heat of Higher Rates
As the economy has rebounded and inflation has been surprising on the upside we have seen investors reprice longer term interest rates higher. As this has been occurring the growth companies, especially the expensive growth companies, have tended to underperform. See figure 3 below, which highlights the underperformance of the MSCI World Growth Index. The relationship is partly due to the longer duration cashflows of these companies, partly due to rising rates reducing the speculative elements in the market and partly due to the improving prospects of many other companies.
The Bottom Line – Less Bullish, More Volatility and Continued Rotation
As the pandemic policy settings are unwound we should expect equity market returns to return more in line with history – think single digits with bouts of volatility. As economic activity normalises and inflation and interest rates rise we continue to see investors rotation from expensive growth to value. The most expensive parts of the market are the most vulnerable to this change in the market environment.