Executive Summary
Reading Time: 7-Minutes
1.01.2022
Executive summary
This outlook reflects the Silver Oak Funds 2022 perspective across several investments and global economic factors. We enter 2022 recognizing that a range of policy and economic outcomes are possible during the reduction of bond buying coupled with increased interest rates on the horizon.
This year the Silver Oak Fund is focused on a two-staged approach examining how the capital markets and economy are progressing. The first stage represents the continued reopening process or growth tied to the mobility of businesses and consumers. The second stage shifts from a pandemic to an endemic where variants slow, and consumer travel rises around a newly thawed global economy.
As we begin the new year, we will remain in stage one; however, 2022 will likely transition during stage one and potentially shift during the third quarter into stage two as the Delta and Omicron variant emerges with less exacerbation. The Central bank actions will remain under transition for the entirety of 2022, shifting away from their pandemic-led activities of bond-buying and near-zero interest rates. The world will also learn more about the Chinese political agenda and desire to participate in capital markets.
10,000 Feet The Global Economic View
Above average for the near term, with meaningful risks from coronavirus and inflation. The economic recovery continues as vaccinations grow worldwide while variant risks add uncertainty. Our 3rd party international Health Checks are lowering risks but still above-average. However, rising consumer incomes and inflation could maintain above-average growth in the short-term coupled with pent-up consumer spending, which may prolong inflation during the first half of 2022.
What's Happening in Developed economies?
Europe and Japan could return growth in 2022.
The Japanese government is pursuing a new spending policy to accelerate consumer demand, while Europe continues to mend after renewed lockdowns from the recent coronavirus surge.
The supply constraints that have hampered production goods, such as automobiles, should see a return to normalization and benefit growth across Japan and Europe. The Central Bank of Europe and Japan appear unlikely to reduce their current spending policy, providing additional recovery paired with a stronger U.S. dollar.
Additionally, distressed property developers do not appear to be a systemic risk for the 2022 recovery. A headwind in China's aging population reduces economic output relative to chronicles from previous decades, but if Covid unlocking occurs, economic activity may pick up in late 2022.
Reviewing the U.S. equity markets
Positive revenue and profit growth, moderate inflation, and relatively low-interest rates support U.S. equities during the first quarter.
While the fundamentals are favorable, the evolving pandemic and policy responses will influence the pace of recovery. Central banks' varied responses add uncertainty, which lends to the potential of heightened market volatility in the new year. Additionally, fiscal policy changes will weigh on investor sentiments. Company earnings continue to trend higher, serving as the basis for our higher stock price hypothesis.
"The S&P 500 is ending 2021 with projected earnings for the year modestly above $200 per share; consensus expectations at the start of the year were for earnings of approximately $165, according to data providers Bloomberg, FactSet, and S&P Global".
Forecasts are nearing 10 percent earnings growth in 2022. Companies' full-year guidance following the release of fourth-quarter earnings reports in late January and early February will positively impact equity prices throughout the first quarter of 2022.
The S&P 500 is trading at a price-to-earnings ratio (the index's price divided by earnings) of approximately 21 times 2022 projections, a valuation level elevated relative to history but well below the dot-com era extremes of nearly 30 times.
What's happening in the Foreign equity markets?
Foreign developed earnings rebounded sharply though more muted growth expectations support some price appreciation during 2022.
Continued monetary policy appears to support economic recovery; excluding volatile energy and food prices, Japan remains deflated (falling prices). While Europe's inflation is elevated relative to history, policymakers expect currently high energy and supply-constrained capital goods price pressures will ease in 2022. Meanwhile, forward earnings estimates remain upward biased. However, the Omicron variant and potential future variants add uncertainty to continued vaccination and therapeutic progress, supporting the global economy's ongoing recovery and reopening.
Policymakers' responses to virus spread represent the region's key near-term risk.
Before Omicron's appearance, European COVID cases had already surged to new pandemic highs, with Germany, Australia, and the Netherlands hitting record cases. European policymakers have responded with full or partial lockdowns and mandatory work from home restrictions on unvaccinated citizens. Though less severe cases than 2020, restrictions hamper current economic activity as well consumers' confidence and spending plans, aiding in Japan's and Europe's' economic growth and corporate profits.
Will International Supply chain issues remain in 2022?
Ongoing supply chain constraints in the auto sector continue to impede Europe and Japan's industrial recovery in the near term, though longer-term trends such as automation are driving demand for the Technology and equipment sectors. China's deceleration remains a headwind, with emerging Asian economies, including China accounting for nearly 25 percent of foreign developed companies' sales.
Emerging market equities' appear balanced but a wide range of potential outcomes exist.
Although volatility and equity price increased corporate profits by 63 percent in 2021, we agree that a modest 6 percent gain is realistic in 2022.
Valuation, measured by equity prices relative to earnings, is at a 20-year low. Upward-biased earnings exemplify global progress toward economic recovery. Meanwhile, longer-term positive trends with middle-class consumers' increasing purchasing power across Asia, Latin America, and other geographies remain intact.
China's consumers are essential for 2022.
Since the pandemic's onset, China policymakers have pursued a zero-tolerance strategy toward COVID, imposing severe domestic and foreign activity restrictions to mitigate further spread of regional case outbreaks. Though successful in keeping outbreaks contained, consumer spending has not yet commensurately returned to pre-COVID trends, particularly in industries that require close physical proximity, such as travel, tourism, and restaurants. While global demand for China manufactured goods remains strong, supporting employment, vaccination progress leading to loosening activity restrictions remains key to unlocking consumer spending growth and, by extension, emerging market equities' prospects in 2022.
Real asset market overview
Rising interest rates may offset accelerating income, keeping Real Estate returns lower.
Nationally, declining vacancy rates and increasing income combined with high prices relative to income should keep valuations high. However, cheap credit is readily available for property investment. Commercial mortgage interest rates are below the average earnings yield on Class A property. As a result, investors should still generate attractive relative returns on property investments. With the chance for rising interest rates, the difference between mortgage rates and property earnings yields could compress, limiting supply growth as the year progresses.
In 2022, we are likely to experience differentiation among property sectors. Secular growth segments such as cell towers, data centers, and industrial properties should benefit from rising demand, above-average growth rates, and solid fundamentals, though valuations are high. In contrast, the transition to more online retailing and excess office capacity are headwinds for these sectors as rental increases are likely limited.
Rising economic growth and increasing inflation are positive for commodities.
The world's three largest crude oil producers (United States, Saudi Arabia, and Russia) held supply in check this year, and it appears likely major oil exporters will continue to limit supply growth to support prices. Global energy demand should improve as economies continue to recover from COVID. U.S. output growth has been stagnant with limited investment in productive capacity despite higher oil prices.
A shift in corporate priorities from investment toward the return of capital could limit output growth.
Thank you for stopping by and reading our outlook for 2022,
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