In our 2022 outlook, we discussed our expectations for muted market growth, year-over-year. While decelerating from the pace of 2021, growth should remain reasonably strong.
Wall Street firms remain divided over how transitory inflation will be. Most expect it to ease along with supply chain pressures. TIW believes inflation will moderate slightly during the second half of the year. But we do not believe supply chain pressures will abate in 2022. If anything, they may become worse in critical areas.
Policy will tighten and yields will rise. Bond returns are expected to be negative. Valuations remain elevated for nearly all asset classes from a historical perspective. Single digit stock returns are the broad consensus.
Sometimes it is good to know what you don’t know. Let’s call them “known unknowns” that impact future economic forecasts.
What will the outcome of the Build Back Better plan be?
What are the lasting economic impacts of the coronavirus?
i.e. How will the coronavirus affect stock prices and growth expectations?
What will the results be of rising geopolitical tensions be between the US and China?
COVID is not in the rearview mirror. I am not a virologist or scientist, but I believe that the virus is here to stay. We will need to learn to live with the virus if we haven’t already begun to do so.
“Did you get your flu shot this year?”
“Did you get your covid shot this season?”
You see where I am headed with this, right? At some point, I imagine, they will drop the word booster.
US earnings are expected to be reasonably strong in 2022 and valuations outside the US market may begin to look relatively attractive. At TIW, we prefer to focus on market signals and weed out market noise.
The signals that we watch closest include the following:
1. GDP Growth
3. Interest Rates
5. Fed Policy
Focus on Market Signals and NOT Market Noise
Consensus estimates for GDP are ~4% for 2022. The graphic below shows Real Gross Domestic Product expectations from the Richmond Fed.
Global growth is expected to be positive for 2022 with estimated ranging between 4.5% and 5.0%. This is slightly down from 5.6% in 2021. According to the World Bank, global growth is expected to decelerate markedly from 5.5 percent in 2021 to 4.1 percent in 2022 and 3.2 percent in 2023 as pent-up demand dissipates and as fiscal and monetary support is unwound across the world.
Q4 2021E earnings season should so positive revenue and earnings growth, but with deceleration. According to research by FactSet, the blended (year-over-year) earnings growth rate for Q4 2021 is 21.8%, which is above the 5-year average earnings growth rate of 13.7%. If 21.8% is the actual growth rate for the quarter, it will mark the fourth straight quarter of year- over-year earnings growth above 20%. The forward 12-month P/E ratio for the S&P 500 is 21.1. This P/E ratio is above the 5-year average of 18.5 and above the 10-year average of 16.7.
Companies with strong balance sheets, earnings and stable cash flow are best positioned for success in a volatile 2022.
3. Interest Rates and Spreads
Interest rates continue to rise across the yield curve, with the most pronounce change at the short end of the curve. The short end of the curve shows the markets reaction to higher inflation and hawkish Fed policy. Credit spreads continue to remain tight; they are in-line with historical levels.
Treasury Rates – January 18, 2022
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2 Year Treasure Yield
Investors may be wise to be under-weight duration and over-weight credit, with a focus on quality security selection, especially in high yield.
It’s the story of the year for 2022 and as any good economist knows, there is a line between raising rates and derailing economic growth. The Fed has reiterated its hawkish stance, but perhaps this is too little too late. We expect to see three, if not four, rate hikes in 2022. Three rate hikes are currently priced into the markets. Global commodities continue to rise and metals, after a poor 2021 showing, have recently begun to rally as inflationary fears continue.
Please remember that a diversified portfolio of stocks and commodities have historically provided a reasonable hedge against inflation.
5. The Federal Reserve and Central Bank Policy
As aforementioned, the market is pricing in three rate hikes for 2022. The first rate hike is likely to occur in March 2022. And we are likely seeing increased volatility as a result. Fed Fund Futures point to a 1.00% rate by the end of 2022 and it may be even higher than that, when all is said and done.
It is likely that rates may rise gradually through 2023.
Fed Funds Rate Liftoff
Richmond Federal Reserve
St. Louis Federal Reserve
The World Bank