In terms of outlook on the market, there's a few points to mention. Firstly, on the macroeconomic side, we now believe that we are moving into the slowdown phase of the economic cycle. We see 60-65% probability of such outcome in our view.
We believe that this is as a result of the geopolitical risks in Russia-Ukraine impacting both consumer and business confidence, as well as the higher energy prices, soft commodity prices and hard commodity prices also impacting confidence and leading to potential risk of negative economic momentum.
Furthermore, the China zero tolerance policy on COVID leading to sizable shutdowns of regions and also lockdowns of some sizable cities like Shanghai recently, is also likely to lead to some negative economic momentum in what is the second largest economy in the world.
So for us, the scenario of a slowdown in economic momentum is leading us to see the economic cycle as moving to slow down. We think the probability of a stagflation remains low but is rising. So we've increased probability from less than 5% at the start of the year to 10-15% probability, with the highest risk of such being in Europe, given the proximity to the Ukraine-Russia crisis.
In a period of slowdown in economic cycle, the styles that typically have performed well for investors have been quality growth and momentum, and the latter one being important, given that in our view, the earnings outlook in the market is deteriorating.
We are looking at a year, 2022, where consensus has been sitting at about 7% earnings growth year on year at the global level. We believe this is at risk of downgrades, both from companies exiting Russia, which could lead to typically about 1-1.5% downgrades on revenues and profits.
But also in terms of the weaker consumer and business confidence that we predict, which could lead to downward revision to the top line. And finally, the higher inflationary pressures leading to input cost inflation, putting pressures on corporate margins and leading to further downgrades.
So this could be a year that will turn from a low growth year into a potentially no growth year. We have downgraded our estimates on the outlook for global earnings growth to +4% from +7% previously. In this environment, we want to focus on companies that offer consistent growth, structural growth prospects in the medium to long-term as well as companies that have pricing power in order to protect their margins in a period of stronger inflation that is also longer lasting.
On that inflation point, the tricky aspect in terms of outlook is that given the inflationary pressures, we believe monetary policies will need to continue on their path towards normalisation and will need to continue hiking interest rates. And this could be a more sizable hikes and could be more longer lasting as well. As a result, this could lead to a fear in the market of the economy moving into recession. At this stage, this is not our central scenario.
We think there's going to be a slowdown, which is something that will remain a bull-bear debate for the remainder of the year. Really what this is highlighting, is that 2022 is going to turn into a year with very broad potential macroeconomic outcomes ranging from recession, stagflation, slowdown or a return to expansion if things normalise, and therefore that bull-bear debate is going to be very active throughout the year.
In this environment, we continue to focus on the eight term opportunities that we have highlighted in the past. From the thematic point of view, first of all, green and alternative energy, which has in itself been accelerated as a result of European countries focus on trying to reduce or exit their dependence on Russian energy supplies, electric transportation, both high speed railways and electric vehicles as a way to continue to decarbonise economies. 5G telephony, as a way to increase productivity in countries. And, healthcare infrastructure, given the need to upgrade healthcare post the COVID crisis, additional opportunities to us exist in cloud computing and cybersecurity, robotics and automation and the metaverse and quantum computing in particular.
Thank you for listening. It's Zehrid Osmani, Head of Global Long-Term Unconstrained Equities at Martin Currie.
Investors focused on geopolitics with Russia and China seen as key uncertainties
The Russian invasion of Ukraine is leading to a tragic crisis for the Ukrainian people and is resulting in:
- increased geopolitical risks across the world,
- higher risk aversion amongst investors, and
- a potentially negative impact on macroeconomic momentum.
The outcome of Ukraine-Russia conflict is highly uncertain, with the potential risk of the conflict both escalating and widening, which could further push the market into risk aversion. There is the likelihood of a growing focus on China’s territorial claims in the South China Sea, with the second half of the year bringing the focus on President Xi Jinping’s likely third term as leader, and potentially beyond. This could unleash a more pronounced territorial ambition around Taiwan, in turn leading to a flare up in tensions, and adding further geopolitical risk that the market is not currently factoring in. Cyber security attacks could also lead to an increased focus on the digital Cold War which is at risk of escalating. All in all, as mentioned in our 2022 outlook, geopolitical risks are now coming out in the open, which is in our view something that investors should increasingly focus on for the remainder of the year.
Despite the supportive fiscal policy initiatives, notably the infrastructure programs that have been announced around the globe but not deployed yet, the macro-economic outlook we are facing in 2022 is increasingly uncertain. This is as a result of the Ukraine-Russia conflict. The conflict is increasing the risk of deteriorating business and consumer confidence, which could lead to weaker economic momentum. In addition, China’s zero tolerance policy on Covid outbreaks is leading to the lockdown of significant regions and sizeable cities.
This is likely to further disrupt economic activity, bring in more supply chain bottlenecks and production disruptions, which again will have additional negative consequences on global economic momentum. The tragic Ukraine conflict is also leading to a sharp flare up in energy, soft and hard commodity prices, all of which are likely to contribute to further boosting already elevated inflationary pressures. This will in turn force central banks to remain on their path towards monetary policy normalisation, despite the risk of weaker economic momentum.
The Ukraine conflict’s impact on resources, and the supply chain disruptions from the Chinese lockdowns is bringing in a double-supply shock that will likely lead to deteriorating economic momentum, and in our view, a shift of the economic cycle from expansion into slowdown. Stagflation risk remains a low probability event, although as a result of the Ukraine-Russia conflict we are increasing that probability to 10-15% from less than 5% at the start of the year. This risk is higher in the European region, due to the risk of energy rationing as the EU seeks to reduce the dependency on Russian energy supplies and diversify the source of suppliers.
Downward earnings revisions: a low growth year could turn into a no growth year
We believe that the deteriorating macroeconomic outlook is likely to lead to downwards revisions in earning growth expectations. and are likely to be entering a period of earnings disappointments in the next few quarters. This is the result of a combination of lower growth and higher margin pressures. We have revised down our top-down forecasts for 2022E to +4% at the MSCI AC World Index level from +7% previously, and are now two percentage points below consensus (+6%)*. For both Europe and Europe ex UK we now project 0% growth in corporate earnings for 2022E. A year of low growth in corporate earnings in 2022 is increasingly more likely to turn into a year of no-growth.
A year of low growth in corporate earnings in 2022 is increasingly more likely to turn into a year of no-growth.
Focus on companies with supportive earnings and more consistent growth profiles
Given the lower earnings growth expected in 2022, the rising risk of downgrades to capture the Ukraine-Russia conflict and higher input costs, we believe that companies with steady, consistent and superior earnings growth profiles will constitute an area of attraction for investors. Additional downside risks to earnings could come from rising corporate tax rates. This remains a likely scenario in our view, given the need to part fund the highly expansionary fiscal policies in place since the Covid crisis began.
Our estimates for the companies that we cover and are invested in, already anticipate a three percentage point increase in corporate tax rates worldwide. Stronger and longer lasting inflationary pressures could also put further downside risk on corporate margins. This pressure on corporate margins could be exacerbated by the Omicron variant disrupting supply chains and logistics, and exacerbating bottlenecks in the economy, as is currently happening in China.
Thematics opportunities remain plentiful in a world transitioning towards sustainability
For us, as long-term investors, we believe that we are facing an exciting period of higher investment opportunities and strong innovation rates, in a world transitioning towards a more sustainable approach to operating. This therefore brings opportunities in the following areas:
Some of these areas, those related to infrastructure, are supported by the sizeable infrastructure spending initiatives that have been unveiled since the pandemic crisis, some of which are still to be deployed in any meaningful way. As ever, a structured and disciplined valuation approach to assessing these thematic areas of structural growth is key to finding attractive opportunities.
*Source: FactSet as at 31 March 2022.