Prepare Yourself for a More Likely 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.
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The views expressed in this material are the views of Bruce Apted Head of Portfolio Management – Australia, Active Quantitative Equity through the period ended 20 January 2022 and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
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Companies with large market capitalizations go in and out of favor based on market and economic conditions. Larger companies tend to be less volatile than companies with smaller market capitalizations. In exchange for this potentially lower risk, the value of the security may not rise as much as companies with smaller market capitalizations.
Investments in mid-sized companies may involve greater risks than in those of larger, better known companies, but may be less volatile than investments in smaller companies.
Investments in small-sized companies may involve greater risks than in those of larger, better known companies.
The "Value" style of investing that emphasizes undervalued companies with characteristics for improved valuations, which may never improve and may actually have lower returns than other styles of investing or the overall stock market.
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