2022 Market Outlook
December 31, 2021
Market Projections:
We are estimating based on research a 12-month price target on the S&P 500 of 5,200. If this target were to be reached it would imply an ~8% return for U.S. Equities. *
Current consensus has S&P 500 EPS growing by 7.4% in 2022. We have considerably higher expectations for earnings growth in 2022 and estimate low double-digit earnings growth.
We believe there are some areas of the market that could see significant outperformance relative to stock averages. We expect the global economy to fully reopen at some point in 2022 benefiting travel, leisure, value, small caps, and international market segments.
At the Portfolio level we are tilting equity allocations into the Value, Quality and Cyclical factors. We are expecting the average Nasdaq stock to come under pressure as the Federal Reserve tightens monetary policy.
We see inflationary forces continuing into the early part of 2022, while moderating in the second half of 2022. We expect inflation to be running at around 3% by the end of 2022, which is still significantly higher than the Federal Reserve target of ~2%.
Economic Outlook:
U.S. GDP growth expectations is 4.0% for 2022. Global GDP is expected to advance by 4.8%.
Core Consumer Price Inflation (CPI) is expected to peak at 6.8% in 2022.
Fed Fund rates are expected to end around 0.9% for 2022.
Unemployment to hit 3.5% at the end of 2022. This may prove a bit rosy.
Ten Year Treasury yield to hit 2.3% by end of 2022.
Sophomore Slump?
In 2020 we witnessed the steepest and shortest market contraction in our history. The pandemic-induced recession lasted for only 2 months. Around the third quarter of 2022 the current economic expansion will enter its third year. We believe we are firmly in the middle of this economic expansion. Historically, 3rd year bull markets have recorded the weakest stock returns for all bull market years, coming in an avg. of 4.4%. This will also be the second year of the presidential cycle in which the S&P 500 has gained an average of 4.9%. The sophomore year is typically the worst and is often referred to as the “sophomore slump.”
Fixed Income:
We expect another year of slightly negative returns for fixed income. As the Fed tapers its bond purchases, this should lead to wider credit spreads between corporate bonds and government treasuries. There are some pockets that may see outperformance. We still like what Treasury Inflation protected securities offer, as they can provide higher yields correlated to inflation. Floating rate bonds/BDCs may provide a hedge to higher rates as the bonds/loans increase with certain interest rate benchmarks.
For moderate, balanced, and risk adverse investors, high quality bonds tend to do three things: Protect principal in adverse economic scenarios, hedge against equities, and provide income. The third category is certainly being challenged but we believe the other categories still apply.
The bottom line is traditional bond yields are low and if high income is your goal, you may look for alternatives such as Senior Loans, BDCs, Private Credit, closed end funds, etc. This involves taking on more risk as there are rarely free lunches in markets.
Putting It All Together
After 2021's stellar market gains, we expect more modest returns for 2022. Our view is that 2022 will be the year in which the global economy experiences a full recovery. Vaccines, therapeutics, and population immunity should further strengthen a cyclical recovery, increase mobility, and unleash pent up demand. Wages are rising, jobs are plentiful, and household debt levels as a percentage of Income is at the lowest level in 3 decades. If supply chain disruptions finally abate and inflation pressures moderate, we fully expect the domestic and global economy to perform well above average. In most years this would be a great set up for market returns.
However, stocks are priced to perfection and any earnings misses will be punished. Market Valuations are far above historical averages, and we expect the market multiples to trend lower toward their long-term averages. The massive monetary stimulus from the Federal Reserve has supported historically high market valuations and promoted inflation. As a result, the Fed is currently tapering their stimulus efforts and expect to raise rates 3 times in the second half of 2022. In short, the Fed is reversing the monetary conditions that helped to promote last year's stellar gains. While the market adjusts to tighter monetary conditions, we expect significant volatility for 2022.
In conclusion, we expect a high single-digit return for the stock market. Strong underlying economics should support corporate revenue growth, earnings growth, operating margins, and consumer confidence against tighter monetary policy, declining stock market multiples and a sophomore presidential slump.
Risks to Market Forecasts for 2022:
1). Covid 19: New variants with characteristics that evade immunity and increase mortality.
2). Supply shortages turn into Gluts: Inventory shortages can often become excess inventory. If this were to happen, we would expect this to lead to a quick fall in inflation, price cuts and put certain industries at risk.
3). Persistent High Inflation: If supply chains continue to be stressed and the Fed raises rates at a faster level, this could potentially lead to stagflation.
4). Geopolitical: Invasion of Ukraine, social unrest, food insecurity due to price inflation.
*Sources: S&P Global, CFRA, JP Morgan, Charles Schwab, Kiplinger, Credit Suisse, Barrons, Argus, Bloomberg, Morningstar