The U.S. stock market continues to astound with its resiliency, overcoming obstacle after obstacle like a gold-medal track star clearing hurdles. Pandemic? No longer much of a problem. The highest inflation since the ’90s? Not a deal breaker. Record-high stock prices? We’ll pay up—and buy every dip that comes along, no matter how minuscule.
The S&P 500 index logged 64 new highs in 2021 (as of early November), the second-highest annual total in index history. Since our January 2021 outlook a year ago, the broad market benchmark has returned 35.8%, including dividends. We said at the time to expect low-double-digit returns, but that if we were off, it would be because we were too conservative. At midyear, the upper end of bullish 2021 price targets for the S&P 500 among Wall Street strategists reached the 4600 mark. On November 5 (the date for prices, returns and other data in this article), the index closed at 4698.
Will the juggernaut continue in 2022? Our answer is a qualified yes. It has proved to be a mistake to underestimate corporate America, and the market enjoys some strong fundamental underpinnings. But the old challenges remain, and new ones have surfaced. So, once again, we encourage investors to moderate their expectations. You can only reopen an economy once (fingers crossed), and we are likely at or past peaks for growth rates in the economy and corporate profits. “We head into the new year with a glass-half-full outlook,” says Eric Freedman, chief investment officer at U.S. Bank Wealth Management. “But like most market environments, this one is a mosaic of risks, some forecastable and some not.”
For 2022, we expect more-normalized stock market returns. That means something in the high single digits, plus between one and two points in dividends. Think somewhere a bit above 5050 for the S&P 500, or north of 39,000 for the Dow Jones industrial average. For now, in broad terms, we prefer stocks to bonds and U.S. markets over international offerings, and we like the looks of small companies, value-priced fare and companies that do well when the economy does and can cash in on supercharged consumer spending. Later in the year, in a more temperate post-COVID economy, look to larger-capitalization health care and technology names for long-term, stable growth.
Investors will have to pick their spots carefully in 2022 and may not be able to rely on a rising tide lifting all boats—either in broad index terms or even within a particular investment style or sector. “It will be a decent year for stocks if you’re a stock picker, a more modest year if you’re an S&P 500 investor,” says Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
Economic growth, although decelerating from a strong reopening bounce, is expected to remain robust in 2022, with the U.S. leading global developed economies. The health of the American consumer is a big part of the story, says Ross Mayfield, investment strategy analyst at securities firm Baird. “I’m bullish on the U.S. economy and U.S. stocks,” he says. “Our economy is consumer-driven and consumption-based, and we emerged from the recession with consumers in a better position than they’ve been in long-term memory.” Debt in relation to income is down, and debt service is manageable with still low, albeit rising, interest rates, he notes.
The Conference Board, a business and economic research group, forecasts U.S. gross domestic product growth of 3.8% in 2022. That’s down from an estimated 5.7% in 2021 but well above the pre-pandemic trendline of 2.2% from 2010 through 2019. Kiplinger’s forecast of 4.5% growth in 2022 is more optimistic than the Conference Board’s. By 2023, many economists expect GDP growth to fall back to the 2% to 3% range.
With the economy on solid footing, the Federal Reserve has begun to peel away the crisis measures it instituted when the pandemic first hit. The Fed announced in November that it would start scaling back its massive bond-buying program, a process likely to conclude next summer. The last time the Fed tapered a bond-buying program aimed at shoring up the economy, in 2013 and 2014, the stock market dipped in a so-called “taper tantrum” but recovered nicely. (To see how various asset classes performed then, see the chart on page 28.)
The central bank will likely start raising rates in the second half of 2022. Kiplinger sees two quarter-point hikes in the Fed’s short-term benchmark rate in 2022, with hikes continuing into 2023. Look for the yields of 10-year Treasury notes to reach 2.3% by year-end 2022, up from 1.5% recently. Rising rates put fixed-income investors in a bind, because bond prices typically move in the opposite direction of rates. You’ll do best by venturing beyond plain-vanilla Treasuries. “Most of our fixed-income picks are what we call non-core,” says Shalett, “in areas like bank loans, preferred shares, convertible bonds, select mortgage-backed securities—a lot of it is very nontraditional.” (For more on our bond market outlook, see “Income Investing,” on page 48.)
Given today’s challenges, corporate profits are surprisingly strong, despite the trials of the pandemic, rising production costs, supply chain snafus and labor shortages. U.S. companies recorded a brilliant third quarter, with an earnings growth rate for companies in the S&P 500 expected to be 41.5% when all the reports are tallied, according to earnings tracker Refinitiv. Nearly 81% of companies beat analysts’ estimates—in a typical quarter, only 66% do so. When the books close on 2021, analysts expect profits to be up 49% from 2020 levels. Earnings will come back to earth in 2022, with analysts expecting annual growth more along the lines of 7% to 8%, closer to the long-term historical average. Expect the strongest growth in industrials and energy stocks, plus the consumer discretionary sector (companies that make or provide nonessential goods or services).
For investors worried that a stock market at all-time highs is too pricey, the strong earnings support should allay some fears. The market “meltup” in 2021 (the opposite of a meltdown) has been led by a melt-up in earnings rather than by the inflating price-earnings ratios that drove stocks in 2020, notes economist and market strategist Ed Yardeni. “An earningsled bull market is much better than a P/E-led bull market; it’s less prone to sell-offs because it is supported by fundamentally strong earnings,” he says. The S&P 500’s P/E has drifted down from a high of more than 23 to just over 21 recently, even as the index keeps climbing. “That tells you how great earnings growth has been, says Tony DeSpirito, chief investment officer of U.S. Fundamental Equities at investment giant BlackRock. “That’s been kind of lost on people.” (To see how much P/Es, earnings and dividends have contributed to total returns, see the chart on the next page.)
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