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Stock Market Monitor: Q1 2022 equity market outlook

  • Nigel Bolton


Select the right stocks to weather inflation. Company analysis is critical as supply and demand imbalances lead to more persistent inflation – a situation that may be prolonged by new COVID variants. Our view ahead of 2022:

  • We are positive on equities but rising rates and inflation may bring volatility
  • Pricing power and sustainability are key company differentiators
  • Tackling food emissions with innovation a big investment theme

We see global stock markets making high single-digit returns in 2022. Yet inflation uncertainty makes stock selection critical to market-beating performance.

Consumer-powered economic growth coupled with continuing negative real interest rates will help deliver positive gains for equities in 2022, in our view. Stock market valuations may de-rate slightly as interest rates and bond yields gradually rise. But we expect strong corporate earnings to more than make up for this and push market levels higher.

Yet the journey for stocks may be more volatile than it has been in 2021 as inflation concerns gain traction. The COVID crisis has jolted the world from persistent deflation to more persistent inflation, in our view. Demand for goods is surging and supply – disrupted as factories shut down during the pandemic – is struggling to keep up.

We believe interest rates may rise only gradually in response to inflation, now that global government debt has soared to more than 100% of global gross domestic product. See the below. This means we could see negative real interest rates and bond yields in developed markets for several years – or even decades. Investors may start to question the role of government bonds in portfolios and increasingly switch into equities for growth and income to help protect their savings from inflation.

Debt surge
Global government debt levels, 2000-2021

Chart showing rising global government debt levels, 2000-2021

Source: BlackRock Fundamental Equities and the Institute of International Finance, Dec. 2021. The chart shows total global government debt levels as a percentage of total global gross domestic product.

How equities can offer inflation protection

The conversations we have with companies about supply and labour stresses lead us to expect inflation concerns to continue in 2022 and beyond. The key to navigating this environment is to focus on choosing fundamentally strong stocks that can deliver superior earnings and cash flow growth.

Price persistence

Supply chain disruptions are causing raw materials costs to soar. For example, the prices of steel and resins have more than doubled for some home appliance makers. This situation may get worse before it improves, as pre-existing contracts for materials expire and companies must buy again at higher prices. Where companies can, they will pass on rising costs to their customers. But they may do so only gradually to avoid losing market share – allowing inflation pressures to run longer.

Companies are stockpiling input materials as they move from a focus on inventory efficiency to resiliency. The aim is to build a buffer as components and products get stuck in transit – some goods are spending 50 days longer at sea than they were before COVID – but this adds to storage costs. And companies are seeking to add to their number of suppliers, moving from the cheapest single source to many sources. Finally, some of the world’s largest private employers are boosting wages to attract and retain staff as furlough schemes come to an end and people reconsider their working lives. Companies say around half of these increases could “stick.”

Signs of stress relief

We see some reasons to expect supply chain pressures to subside later in 2022. Demand for goods is soaring partly because consumers have been unable to spend on travel, dining and live entertainment during the pandemic. The chart below shows how goods inventories in developed markets continued to fall even as manufacturing ramped up. But the tide could turn once borders start to reopen and people feel more comfortable to travel – although the Omicron variant may delay this outcome. Direct action – such as adding extra shifts – is being taken by governments and logistics companies to unplug some of the busiest ports in the world, where ships and containers are being held up due in part to a lack of dock workers and truck drivers.

Mind the gap
Developed market PMI breakdown, 2015-2021

Global profit margins and margin forecasts, 1999-2023

Source: BlackRock Investment Institute and Markit, with data from Haver Analytics, Oct. 2021. The chart shows the 3-month moving average for developed market purchasing managers indices (PMI) subcomponents for stocks of finished goods (orange line) and manufacturing output (yellow line)

Selectivity matters more

We spend our time on in-depth, company-level research to find those companies that we believe can continue to beat earnings expectations even as their costs rise. Those that don’t may see earnings disappointments and large dents in their value, as we have seen in recent earnings seasons. Here are some characteristics we look for:

Pricing power. The ability to pass costs on to customers is crucial if companies are to maintain profit margins during inflationary periods. Pricing power often comes with a strong brand, and the best brands are to be found across sectors. Some of the European luxury and beauty names should continue to prosper – especially those that invested in e-commerce over the past decade and those that appeal to the growing middle class in emerging markets.

Asset-light companies. Companies that have embraced digitalisation to lower the levels of assets they own can mitigate the impact of supply disruption. We focus on companies with unique intellectual property and strong market share. Some of the big tech and software companies remain compelling amid accelerating digitalisation across sectors, and as part-time work-from-home becomes the norm. Quality characteristics like balance sheet strength and the ability to grow free cash flow are especially important during periods of inflation.

Sustainability. We are going to see heavy capital expenditure in the U.S. and Europe as governments pass infrastructure spending bills. Yet not all construction and building companies will benefit. There is an emphasis on “green” spending, so we look for those companies – such as insulation providers and heat pump manufacturers – that can play a part in reducing carbon emissions. We also like companies linked to the surging demand for EVs – global EV sales nearly doubled in 2021 from the year before – such as semiconductor makers and some of the EV start-ups themselves.

Spotlight topic: the future of food

More than 30% of global greenhouse gas emissions derive from agriculture and food production[1]. Most of these emissions come from the rearing of animals to produce protein – 337 million tonnes of meat were produced in 2019, up 44 percent from 2000[2] – which results in deforestation and high levels of methane released into the atmosphere. This represents a colossal challenge as the world seeks to transition to a net-zero economy.

31% of global greenhouse gas emissions come from agriculture and food production

We seek to invest in companies that provide solutions for climate-conscious consumers and increase resource efficiency. These themes are going to be drivers of higher earnings growth in the medium and long term, in our view. We focus on companies that operate in the following areas:

Agricultural technology. Automation and connectivity can help reduce the resource intensity of farming. One example: Technologies are emerging that use artificial intelligence to reduce herbicide use by 90%. 

Supply chain and energy efficiency. Online grocery specialists have been shown to reduce food waste by up to 15 times when compared with those supermarkets that operate mostly through physical stores.

Meat alternatives and lab-grown meat. Three generations of technology provide alternative protein to animals reared outdoors: plant-based meat; meat produced by precision fermentation, where a microorganism such as yeast is edited to produce protein; and cell culture technology, where muscle cells are put into a bioreactor and fed sugar so they can proliferate.

Nigel Bolton
Co-Chief Investment Officer of BlackRock Fundamental Equities

[1] Food and Agriculture Organization of the United Nations, Nov. 2021
[2] Ibid