Stock outlook 2022: will the bulls dominate or tougher times ahead?
It has been another spectacular year for the stock markets, as the pandemic-induced stimulus has kept the rally on Wall Street alive even though the threat of the virus has yet to recede. The picture has been a bit more mixed in other parts of the world like Asia, but overall 2021 has been fantastic for most risk assets. So what have been the driving forces behind these moves and can the positive trend be sustained in 2022, when most central banks have started to withdraw stimulus measures and high inflation becomes embarrassing?
From the first dose to the reminders
Let’s go back 12 months. Covid-19 vaccines were all the rage as everyone was betting they would end the pandemic. Those hopes were dashed when the Delta strain arrived. Investors have yet to fully decide on the Omicron variant, and it will likely be the biggest test for stocks in early 2022.
Markets were quick to dismiss the risks of Omicron due to all early results suggesting this new strain is not as dangerous as the previous ones. Yet these early studies also show that Omicron may be up to four times more transmissible than Delta. White House chief medical adviser Dr Anthony Fauci emphasized this best when he said: “when you have such a high volume of new infections it can replace an actual decrease in severityâ.
Traders have tried to stay bullish, hoping the vaccines will keep major economies relatively open throughout this latest wave. While the start of 2021 was marked by the race to get everyone’s first dose, the final weeks of the year will surely be marked by the race for booster shots, which have proven to offer substantial protection against the news. variant.
But the issue isn’t just whether Omicron will mean further lockdowns. When so many people are infected and have to self-isolate, it would inevitably lead to large-scale business disruption, as happened over Christmas weekend in America with the airline industry. And that brings us to the other big headache of 2021 that is set to last until 2022: supply chain bottlenecks.
Supply chain chaos is brewing
When U.S. companies released their third quarter earnings, investors were greatly relieved that most companies had managed to contain costs driven by supply and labor shortages, posting stellar quarterly results. Some businesses, mostly retailers, have of course been more impacted than others and therefore their inventories have been hit more, while others have warned of tougher quarters ahead.
Policymakers expect supply constraints to be resolved in 2022. However, so far there is no sign that global bottlenecks will ease anytime soon. Omicron further complicated the picture. But even before that, its predecessor Delta was making inroads into new regions, with some Chinese cities the latest to face instant lockdowns.
Supply chain issues pose a double risk for businesses. Not only do they hamper production and increase input costs, but sustained price increases, if passed on to consumers, ultimately result in higher borrowing costs as well. This is possibly the biggest threat to stocks in 2022, especially Wall Street, which has eased in the face of the prospect of a Fed interest rate hike in the coming months.
Stimulation taps are off
The abundant stimulus that flooded markets until recently bolstered inventories when negative Covid headlines hit during the pandemic. But one of the biggest turning points of 2021 was when central banks moved away from their extremely accommodating stance and began to scale back their pandemic-era stimulus measures.
With the rhetoric about high inflation being transient and now dead, policymakers want to put the brakes on the price hike. The Fed raised its projections for the fed funds rate in December, forecasting increases of three-quarter basis points in 2022, in line with market expectations.
Are rate hikes no longer feared?
So why aren’t the markets panicking? All three of Wall Street’s major indices are set to end the year at new all-time highs, including the highly technical Nasdaq, which struggled to rebound after the November / December sell-off than the S&P 500. European stocks are a little further away from their annual highs but are rebounding quickly.
One of the reasons investors remain bullish is that financial conditions have not tightened significantly after the Fed’s hawkish pivot. The yield on 10-year Treasuries has not hit a new post-pandemic high since March, hovering around 1.45% in December. Wall Street seems comfortable with this level. Moreover, it suggests that the markets believe that interest rates will not peak very high as the Fed’s early action will be successful in curbing inflation.
Real yields in the United States have also not risen much despite the Consumer Price Index approaching 7%. In fact, real yields have remained near all-time lows as 2021 draws to a close. Until yields start to rise significantly, markets will not be frightened by the Fed’s current âmodestâ tightening plans.
Are 5,000 on the charts for the S&P 500?
If inflation does stabilize at some point in the first half of 2022 and there are no other setbacks with the coronavirus such as more disturbing mutations, the US and global stock markets would be ready to extend. their earnings for a fourth consecutive year.
The S&P 500 is on the verge of breaking through the 4,800 level and the next major target after that is the 5,000 milestone. However, the latest rally may first stall around the 4,810 which is a long time ago. Natural for the rally to pause as it is near the 200% Fibonacci extension of September’s pullback.
Growth stocks should prosper the most if inflation risks start to ease and financial conditions remain accommodative. The big names in tech should also continue to do well, especially those paying high dividends. Health care, energy and communications services are a few other potentially winning sectors.
Many risks lurk in 2022
The Fed could of course become more aggressive if Omicron were to prove to be truly less severe than expected, and furthermore, Senate Democrats are giving the green light to President Biden’s $ 1.75 trillion spending plan, which is currently under review. suspense.
Longer term, the midterm elections in the United States in November 2022 could produce shocks, as Democrats risk losing both houses of Congress if they and President Biden continue to see their popularity decline.
In the immediate horizon, however, the focus is on Omicron’s impact and when inflation will peak. In a worst-case scenario, further supply disruptions from Covid could push prices even higher, adding further pressure on central banks to act, reigniting fears of stagflation, which luckily did not occur. not materialized in 2021.
Value stocks such as financials, energy and certain industries are more likely to perform better in such an environment, while growth stocks as well as consumer discretionary and small-cap technology companies could be investments. more risky.
Growth stocks tend to have higher valuations and the tech sector is teeming with astronomically high price / earnings multiples. With the exception of mega-cap tech companies which have defensive characteristics, overvalued tech stocks are the most exposed to persistent inflation that fuels a long-term rally in yields and forces the Fed to rise more aggressively.
European and Chinese policymakers are going in different directions
In Europe, the continent’s generally stricter response to the surge in Covid cases is expected to weigh on growth prospects for another year. However, just as was the case in 2021, the ultra-dovish policy of the European Central Bank should keep the momentum positive. The ECB is now the only one that continues to believe that inflation will come down on its own and a rate hike next year is highly unlikely.
At the other end of the monetary policy spectrum, China’s central bank is on an easing path as the rise in inflation has been more modest and manageable there, which should support the region’s stocks, which have underperformed lately. China’s regulatory assault has weighed on the domestic tech sector, and crackdowns could expand into 2022. But of even greater concern is the country’s struggling real estate sector, which is growing in debt.
So far, authorities appear to have a grip on the fallout that has been sparked by fears that real estate giant Evergrande will default on its debt. However, the real estate woes are far from over and could still trigger concerns in the stock markets over the next 12 months.
Will the downward buying mentality continue in 2022?
After a very eventful year in which investors embraced every trough, overall financial market volatility abated as trading thinned over the holidays. Don’t be fooled, however, into thinking that 2022 will be calmer. If anything, the year ahead could be even more volatile given the unpredictability of the scale and duration of inflation, and how quickly the pandemic becomes endemic.
But if 2021 has proven anything, it’s that there isn’t much of an alternative to stocks for investors looking for decent returns, especially now that inflation is on the rise, making bonds look low. yield even less attractive than they already are.
Much will also depend on how strong fourth quarter earnings are. The last three months of the year will probably provide the best indication yet of the severity of supply shortages and workforce dislocation that are hurting profit margins and the extent to which the epidemic is ‘Omicron has distorted corporate profit forecasts for the next few quarters.