Asian stocks will have a roller coaster ride early in 2022, clouded by uncertainties ranging from the pandemic and higher inflation, to the broad shift to a tighter central bank policy, which has mostly languished on the easy monetary path for more than a decade.
From bitcoin to Asian stocks, risk-friendly assets have registered slight gains recently, buoyed by ebbing concerns over the severity of the new COVID-19 variant.
Still, analysts warned not to read too much into these market moves going into the year-end, given reduced liquidity from the thin holiday trading volumes.
The MSCI’s broadest index of Asia-Pacific shares outside Japan rose slightly on Friday after the S&P500 index registered a record closing high the previous day.
Studies have shown the Omicron variant is less lethal than the Delta strain, and is unlikely to derail the global economy, fueling optimism that the fallout from new coronavirus-led restrictions would be limited.
But for Asian stocks, the risk of runaway prices and different paths taken by major central banks underline deep uncertainties, and more importantly, the pandemic’s scars have not yet fully healed and still run deep.
What has not helped the outlook for Asian equities is China’s property market downturn, triggered by the collapse of developers such as Evergrande, which analysts expect to be a significant drag on economic growth.
While it is difficult to gauge the exact size of China’s residential property sector, various estimates suggest a ballpark of around 20 percent of the country’s gross domestic product.
Three main uncertainties
“The three main uncertainties for 2022 are the durability of the spike in inflation, the extent and duration of the property-market-driven slowdown in China and possible further COVID-19 lockdowns as infection rates increase again or new variants emerge”, said Andrew Pease, Head of Global Investment Strategy at Russell Investments.
“COVID-19 refuses to disappear as a risk. New variants that are resistant to current vaccines are the main threat. We don’t yet know the implications of the omicron variant, but it highlights the uncertainty that exists around COVID-19 scenarios. Markets will be volatile around the news of rising COVID-19 cases”, he added.
At the beginning of 2021, general expectations for a rebound in trade, tourism, and commodity prices fueled optimism for Asian stocks. But this time around, the sentiment is negative, with analysts concerned equity markets in the region would struggle further.
“At face value, equities in emerging Asia have fared poorly both in recent weeks and over the entire year. Even if virus concerns abate, we doubt that 2022 will see a spectacular turnaround for emerging market equities”, said Nicholas Farr, an assistant economist at Capital Economics.
“In our view, the headwinds facing China’s equities will continue in 2022, and we suspect the strong export demand that has propped up earnings in emerging Asia generally will eventually begin to unwind”, he added.
Inflation and policy risks
With no clear signs that the pandemic has abated, or that the price-fueling mix of clogged global supply chains and strong demand would be temporary, the outlook has further darkened for Asian equities heading into the new year.
Higher price pressures through most of 2021 have changed the tune of some major central banks, if not all, to higher for longer risk from transitory, making inflation the more pressing threat.
As a result, Britain became the first among the Group of Seven economies to raise interest rates. The U.S. Federal Reserve also signaled more aggressive policy tightening in 2022.
“Inflation tops the list of concerns heading into 2022. We still expect it will prove mostly transitory, but this may not be apparent until the middle of the year”, said Russell Investments’ Pease.
While in Europe, the pandemic stimulus was dialed back slightly, European Central Bank President Christine Lagarde clearly outlined that the top risk was the pandemic, which was again depressing spending in the region and threatening the economic recovery.
Lagarde said some countries had reintroduced restrictions, which could hurt the recovery and weigh on business activity and sentiment.
The Bank of Japan kept monetary policy ultra-loose in Asia but reduced its emergency pandemic funding.
The differing monetary policy paths of those major central banks and their focus has set the agenda for a tumultuous 2022 for Asian stocks.
Be it pandemic-related worries about economic growth or higher-inflation-led policy tightening, either of those will hurt risk sentiment, more so for emerging markets.
“News on Omicron is likely to continue to be a key driver of EM equity prices for a while. But the big picture is that even if current worries about it abate, we don’t expect major EM equity indices to make particularly large gains”, said Capital Economics’ Farr.
“For one, we think EM earnings growth may disappoint if, as we expect, commodity prices generally decline further and the boost that Asia’s tech exporters are receiving from pandemic-related demand eventually fades. Even though valuations have declined a bit this year, we don’t see much scope for them to rebound, given our forecast that real ‘safe’ asset yields will generally rise over time”, he added.
For a long time now, investors have expected major central banks to react with higher interest rates to keep prices stable, a clear mandate, or at least a significant focus part of their target.
The primary tool for policymakers to stabilise prices is to raise interest rates, which in turn pushes up borrowing costs and discourages consumers from buying big-ticket items like homes and cars and undercut asset values, further depressing demand and prices; through a “wealth effect”.
For one, the Fed has reacted strongly, making price stability its focus by committing to end its asset purchases by March and suggesting an accelerated timetable for interest rate increases.
Analysts were also concerned that accelerated policy tightening might short-circuit the economic recovery and bring forward the next recession.
“There is another risk to be considered: a much stronger than anticipated surge in demand if COVID-19 fears prove unfounded”, Please said.
“We have a low probability of this outcome, but it would be double-edged if it occurred. There could be a blow-out rally in equity markets, but there would also be significant Fed tightening which would threaten an earlier end to the economic cycle”, he added.