Covid variants, liquidity crunch: Key risks for global equities in 2022

After a stellar run in 2021 that saw the S&P BSE Sensex and the Nifty50 clock gains of 20 per cent and 22 per cent respectively, global equity markets, including India, are gearing up to welcome 2022 on a cautious note.

For one, new variants of the Covid -19 infection that make current vaccines less effective is one of the key risks worth flagging, analysts said. Inflation was also a risk for this asset class in 2021, although most market participants expect that the current elevated inflation levels will be transitory. However, stickier-than-expected inflation could lead to tighter monetary conditions and increase the risk of a policy error – both of which would be headwinds for global equities.

Additionally, there could be less room going forward for fiscal stimulus, which has been a supportive element for equities during the COVID-19 crisis. This is because governments will likely wind down their unprecedented fiscal policy, and there could also be policy gridlock following the US midterm elections.  

Policy makers in Asia, according to Morgan Stanley, will be able to normalise policy gradually, contingent on the pace of recovery, inflation dynamics, and the implications of the Omicron variant, rather than on the Fed policy path. 

“The risk is that if and when US 10-year real rates rise sharply in a short span, this would create volatility in Asia’s financial conditions, though we believe that the eventual impact would be more muted than in 2013. If this risk scenario pans out, we see India and Indonesia as the more exposed economies,” wrote Chetan Ahya, chief Asia economist at Morgan Stanley in a co-authored note with Derrick Y Kam and Jonathan Cheung.

Growth in corporate earnings, too, could be at risk in the backdrop of rising input costs and wages. Another related risk is further disruptions in supply chains as major global economies resort to lockdown and mobility curbs to stem the spread of Covid infections – a factor that started to weigh on some companies’ profitability in the second half of 2021. 

While most analysts agree that the road ahead for equities as an asset class will remain bumpy given the headwinds, market return in 2022 on an overall basis, they believe, will track the growth in corporate earnings.

“We believe that earnings should remain the key driver of equity returns in the year ahead, enabling equities to deliver sound, though somewhat lower, single-digit returns,” said Michael Strobaek, global chief investment officer at Credit Suisse in a recent note.

 

Slew of initial public offers (IPOs), especially Life Insurance Corporation (LIC) and the National Stock Exchange (NSE) in 2022 that may hit the street in 2022 is another reason why the secondary market liquidity may suffer.

"Sectors/stocks exposed to markets with rising COVID-19 cases / greater prevalence of the Omicron variant may underperform. Expect sector rotation to continue and defensives like Pharma, information technology (IT), and Consumer to make a comeback till sentiment improves. Equity valuations, after the pullback, at 23.3x/19.4x FY22E/FY23E Nifty EPS are relatively reasonable now,” wrote analysts at Motilal Oswal Financial Services in a recent report.

China also remains a potential risk for global equities, e.g. due to a slowing economy and the risk of further regulatory headwinds. Finally, there are several elections to keep an eye on in 2022, such as the US midterms and the presidential elections in France and Brazil that analysts are keeping a watch on.