A matter of interest rates

If 2022 will be a good year for the stock markets depends for Dr. Jens Ehrhardt primarily on the development of interest rates and inflation. If the U.S. Federal Reserve decides to tighten its monetary policy only cautiously the stock markets could be in for another good year. However two black swans, Corona and China, are also lying in wait.

The year 2022 will be dominated by the development of interest rates. If the inflation trend forces the U.S. Federal Reserve to raise interest rates more sharply (the futures market had already priced in up to three by the end of 2022), it will most likely be a bad year for the stock market. The good economic development of the last few years was only possible because of the interest rates lowered by the central banks. Consequently, record high debt ratios have been matched by historical lows in debt service. However, if interest rates rise this will have a massive negative impact on the economy in terms of consumption and investment. The fact that valuations are historically high and investors' overinvestment in equities has reached historic extremes will then also have an impact on the stock markets.

If, on the other hand, the U.S. Federal Reserve sees through the current wave of inflation and sticks to its view that inflation will fall significantly again next year and refrains from raising interest rates accordingly, 2022 could be another very good stock market year. In the past, all stock market years with an index gain of more than 20 percent (as has been the case so far this year) have generally been followed by upward movements in the double-digit percentage range in the following year. If interest rates remain low, there is indeed no investment alternative to equities - and the current investment wave in the USA (the strongest in the post-war period) is likely to continue. This would mean that further increases in profits are predetermined.

Wage-price spiral not in sight

In fact there is hope that important inflation components such as the oil price will ease again significantly in the coming year. The price increases for goods should trigger an increase in supply, which should also lead to lower prices again after the usual hog cycle. Inflation in the service sector is more difficult to assess. In the USA there is a shortage of employees, particularly for unskilled work. Here, wages are likely to continue to rise at double-digit rates. On the other side the salary trend for employees with higher education is not different from that in the pre-pandemic period, so that the development of a wage-price spiral is not realistic from today's perspective - in complete contrast to the 1970s.

Dollar and gold with the potential to rise

Among currencies, the trend of the dollar should remain friendly. While the Bundesbank has always been an international pioneer in fighting inflation, the ECB has shown the least signs of an anti-inflation policy worldwide. Therefore, the euro is likely to depreciate further against the dollar - with a continuation of the record high inflation in German import prices. Accordingly producer prices in Germany, which are already at a 30-year high, will also continue to rise. In the euro country Spain producer prices even rose by 31.9 percent year-on-year. In view of high inflation rates a flight into real assets cannot be excluded despite the high prices of real estate and the stock indices. This would correspond to the usual picture of a depreciation boom.

Gold should also be able to pick up again after a disappointing year in dollar terms. However, in euro terms the gold prices actually rose slightly in 2021. Buyers from India and China have returned in 2021. The previously depressing selling by U.S. ETF investors is likely to come to an end as inflation continues to rise. If gold prices pick up gold stocks should rise at an above-average rate.

Black Swan: China remains a risk factor - especially for Germany

China could become the black swan of 2022. Up to now the real estate economy has been the main economic driver, but this is no longer to be expected in the future. Property ownership at 95 percent is far above the German level of less than 50 percent, the population is declining and the considerable growth in urbanization seems to be coming to an end. The high vacancy rates (Chinese invest most of their savings in real estate) could burden the prices, which in turn should cause sales of vacant properties. The very high Chinese interest rates, in contrast to those in the West, are likely to cause problems for private and especially corporate debt, which has grown considerably in recent years. A poor economy would hit Germany in particular, since it is the world's largest exporting country outside China.

Covid - the Sword of Damocles over China's Economy

The Covid problem remains unpredictable. Although attempts are being made to avoid lockdowns worldwide from an economic perspective, consumer behavior is likely to be dampened nonetheless. Consumer behavior in China has already deteriorated sharply as a result of the real estate crisis. While Western countries are openly or covertly pursuing the immunization strategy started by Sweden, China is the only country to have taken a different path with its zero-Covid strategy. With only limited opening as recently seen in the U.S. China could face a massive Covid problem that is not previously anticipated by any side. China therefore has the choice: zero Covid strategy resulting in continued weak growth, which the country has not known for decades or opening up and more economic growth, but infection figures of perhaps over one million people per day.


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