© Reuters. PHOTOGRAPHY: People were seen on Wall Street in front of the New York Stock Exchange (NYSE) in New York, USA, March 19, 2021. REUTERS / Brendan McDermid / File Photo
NEW YORK (Reuters) – The U.S. stock market is expected to deliver a triple stellar annual return, but the chances of a similar impact in 2022 could be jeopardized by stronger Federal Reserves, slowing earnings growth and a relentless pandemic.
With just over a week into the year, it is on track to increase by 87% since the end of 2018, its best three-year performance in more than two decades. The benchmark index has risen 25% so far in 2021 after double-digit yields in the previous two years.
If history is a guide, next year’s gains may be less impressive, though not necessarily bad.
The S&P 500 has recorded three years of double-digit returns nine times since 1928, according to Jessica Rabe, co-founder of DataTrek Research.
Profits in the year after such periods were on average weaker, with an average index of 8.4%, compared to an overall average total return of 11.6%, DataTrek found. Shares rose in five of those nine years and fell in the other four.
“The prospect of carrying this kind of positive momentum to next year is a coin toss,” Rabe said in an email comment to Reuters. “But the effect of S&P has historically been asymmetric because the positive returns were much higher than the negative ones in the fourth year.”
Reuters’ poll of strategists earlier this month predicted that the S&P 500 would end in 2022 at 4,910, up 4.5% from Wednesday’s close.
Three projected increases in Fed interest rates in 2022 – a more aggressive path than markets expected a few weeks ago – will be at the top of investors ’minds, threatening to boost bond yields and undermine relatively risky assets such as stocks.
But economic growth that encourages the central bank to raise rates can also help lift stocks.
According to a Deutsche Bank study of 13 hiking cycles since 1955, the S&P 500 returned an average of 7.7% in the first year the Fed raised rates.
“We still see a decent environment for equity investors in 2022, although we don’t expect the kinds of gains we’ve seen,” said James Ragan, director of wealth management research at DA Davidson, who expects medium-digit growth for the S&P 500 in 2022.
Ragan prefers sectors that will particularly benefit from a solid economy, such as finance, industry and materials, as well as companies that can pass on price increases during an inflationary environment.
“We think it’s still a good environment for overall GDP growth, which should allow companies to keep growing wages, but we’re worried about estimates,” Ragan said.
EARNINGS STRONG ENOUGH?
Rising bond yields, which typically follow higher rates, could press on already stretched stock values, as projected corporate cash flows will be discounted at higher rates in standard stock valuation models.
According to the Refinitive Datastream, the S&P 500 trades about 21 times compared to 12-month earnings estimates, compared to a historical average of 15.5 times.
While strong earnings can still strengthen the stock case, S&P 500 earnings are expected to grow 8.3% next year, after a nearly 50% recovery in 2021, according to Refinitiv IBES.
“Earnings and revenue growth should be enough to increase the stock market, but there is a risk if they disappoint,” said Michael Arone, chief investment strategist at State Street (NYSE 🙂 Global Advisors.
The earnings picture is also blurred by uncertainties surrounding COVID-19, as the Omicron variant https://www.reuters.com/business/healthcare-pharmaceuticals/how-worried-should-we-be-about-omicron-variant-2021 -12- 14 reigns around the world. While investors doubt the widespread US government-linked blockade on the virus will return, consumers “could spend more cautiously amid a resurgence of Covid infection,” according to a recent Oxford Economics note predicting a 4.3% increase in consumer spending in 2022 after a record 2022 growth of 8.1% this year.
Another wild card for investors will be the U.S. by-elections in November, and control of Congress by President Joe Biden’s Democratic Party is seen as weak.
It remains to be seen whether the stocks of technology and growth, which have led the U.S. market for much of the past decade, can retain their strength. For example, these stocks are particularly sensitive to higher returns because their estimates are more dependent on future earnings.
Wider markets could be in trouble if mammoth growth stocks falter. Profits in six companies – Microsoft Corp (NASDAQ :), Apple Inc. (NASDAQ :), Google Parent Alphabet (NASDAQ 🙂 Inc., Nvidia (NASDAQ 🙂 Corp., Tesla (NASDAQ 🙂 Inc. and Meta Platforms Inc., former Facebook (NASDAQ 🙂 – accounted for approximately one – a third of the S&P 500’s total return in 2021 since closing on Tuesday, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
“We may begin to notice poor performance in technology and better performance in sectors that are undervalued,” said Andre Bakhos, CEO of New Vines Capital LLC in Bernardsville, New Jersey. “By the nature and design of S&P, you would probably get a lower market.”