Editor’s Note: This article is part of Joanna Makris’ Behind the Wall series, where she provides retail investors with the insider scoop on the hottest technologies and trends from today’s business leaders, industry experts and money managers. Today’s discussion is with Steve Ricchiuto, Chief Economist for Mizuho Securities USA.

With the year drawing to a close, it’s time to start thinking ahead. From a stock market perspective, the times they are a-changin’. Here to make sense of what’s going on and how to play by the new rules, we sat down with Steve Ricchiuto, Chief Economist for Mizuho Securities USA.

By any measure, fiscal policy is shifting from a tailwind to a headwind in 2022. Investors are understandably reacting to a more hawkish Fed and rotating into sectors with more positive exposure to rising interest rates.

Ricchiuto’s thoughtful understanding of macroeconomic trends is a great starting point for anyone re-thinking their 2022 investment strategy. But, the economist’s best wisdom is on how to invest in a slowing economy.

Spoiler alert: growth stocks are “defensive stocks.” Investing well in 2022 means finding the right combination of revenue and earnings growth.

Read on for the economist’s views on what to expect in 2022. We talked housing, labor and the supply chain: everything that matters the most to your wallet and portfolio. Ricchiuto will tell you why 2022 forecasts are too optimistic — and how 2022 could be the year of corporate share buybacks. He’ll even shed some light on Chinese tech stocks. 

A ‘Less Confident Environment’… For Now

Ricchiuto recently bumped up his Q4 growth expectations (from 4% to 6%). But the economist’s message for 2021 was very clear: things are cooling.

“I think in the first half of the year, it’s all headwinds…which was different [from] what we saw in 2021,” says Ricchiuto. Rising short-term interest rates, a tightening Federal Reserve and a flattening yield curve combine for “a less confident environment for corporations going forward. It also makes it harder for banks to make money in lending, and therefore they pull back on their lending. So it creates an environment of a slower GDP area.”

How much of a slowdown should we expect? “By the end of next year, we’ll be looking at growth rates of closer to two to two-and-a-half percent on average going forward,” says Ricchiuto. 

While the economist expects declining growth in the first half of 2022, market sentiment is likely to improve as the year progresses.

“As… we begin to recognize that the economy has slowed, the inflation numbers have come off the boil, wage numbers haven’t gone up as much, the Fed isn’t going to be forced to do as much … look for the interest rates to reverse, look for the yield curve to steepen and look for the equity market to … push back up towards higher levels as the year progresses.” 

Stimulus A ‘Net Negative’ for the Economy

Ricchiuto didn’t mince words. He was extremely clear: the market faces several headwinds next year.

“The deceleration that we’re going to get in 2022 is a function of expectations of higher short term rates — i.e. the federal reserve tightening monetary policy,” says Ricchiuto. “That’s why the yield curve has been flattening.”

It’s a familiar pattern. Rising interest rates create a rising currency. And a rising currency compounds the deceleration in growth next year. 

Another headwind for the markets: Biden’s stimulus program. The Build Back Better Act passed through the House of Representatives in November and is currently stalled in the Senate. As Ricchiuto points out, the proposed spending levels aren’t much different than those incorporated in the American Rescue Plan, Biden’s first piece of COVID-19 relief legislation passed last March.

As things currently stand, the Build Back Better Act costs $1.7 trillion, down from its original $3.5 trillion. But tax increases will lead to a slower economy going forward into 2022. The end result: “it will actually be a net negative on the economy,” says Ricchiuto.

Housing Market: Meh

Another area that’s been tricky to predict is the housing market. A combination of recession-induced low mortgage rates, a pandemic-fueled shift to remote work, and a wave of first-time millennial homebuyers created a perfect storm for sky-high prices.

But with housing prices climbing to new records, the big question is how much longer will the housing run last?

For the most part, Ricchiuto expects the present demand trajectory to continue. “Housing is not going to be negatively affected by interest rates in 2022,” he says.

That said, he points to the possibility of the market getting too hot for some buyers. “You wonder whether or not rising prices leads to an environment where it reduces demand because people just simply get priced out of the marketplace.” 

The data is mixed for another reason: to put it plainly, there may not be enough homes to satisfy demand. After years of under-building, Ricchiuto expects an uptick in new construction. “I will warn you that there hasn’t been this big rush to building new product and bringing it to market. And that I think will happen in 2022.”

Increased construction will lift the economy beyond direct value creation. “As actual construction is put in place, dollars spent in the economy actually go[es] up on new construction,” says Ricchiuto, “as opposed to everyone running out and buying existing product.”

Supply-Demand Balance Is Good News for the Labor Market  

Labor has been another major concern across a number of industries. In many sectors of the economy, employers have faced challenges when it comes to filling job openings with fewer workers than there are positions. 

But as Ricchiuto points out, there’s been a permanent change in the labor force, one in which fewer people end up working. “I think a lot of the jobs that are currently counted as open… [are] permanently gone,” he says. “As people reset their business outlooks going into 2022, we will discover that we were holding onto a lot of jobs in our totals of openings that were pre-COVID. I don’t think all those jobs are coming back.”

That means the gap between job openings and job hirings will basically correct itself from both ends in 2022, rather than being corrected all from one end. “I think it’s going to be hard for labor to make back all of the reduction in their purchasing power that’s come as a result of higher prices,” Ricchiuto says. 

Rising Costs Mean Consensus 2022 EPS Estimates Are Too High 

While global supply chain shortages persist, most companies expect easing. But there’s no crystal ball. “I will tell you what I’ve noticed from our inputs is that people or companies are finding alternative ways to avoid the bottlenecks,” says Ricchiuto. The result: higher costs.

“It’s a little more expensive in many of these cases, you have to go to different ports, have to truck product, you have to load it on trains, or you have to bring it in by air. All these factors are clearly weighing on the cost structure.”

As Ricchiuto points out, those rising costs are likely to impact corporate earnings in the coming quarters. “I don’t think corporations are going to be able to pass all of this through to the consumer. And I think at the end of the day, really what happens in 2022 is we have to sit back and recognize that a lot of the growth expectations that we have for earnings are going to be trimmed, which means, yeah, 2022 will be a good year for stocks, but it’s not going to be as good a year as 2021.” 

Another area where costs are rising: oil. But Ricchiuto doesn’t expect rising oil prices to derail a recovery for next year.

“It’s interesting, we were able to grow fine with a hundred dollar-a-barrel oil. We have become much more efficient as an economy in dealing with the energy environment. I mean, an energy shortage, not just a price gain, would be a real problem. But we don’t seem to have those…here it’s a function of price.” 

Defensive Growth Is Not An Oxymoron

With all these moving macroeconomic parts, investors are understandably figuring out which sectors are best-positioned for growth next year. Ricchiuto had this to say: “I really think [it’s] the defensive positions — and I would put growth into a defensive position these days — because growth has been behaving that way. The reality is in an environment where you’re looking for where the economy’s going to do better, the transition that’s going to continue to take place where we substitute capital for labor, it’s really going to continue to benefit the growth sectors.” 

Finally, with the stock market cooling and companies sitting on a ton of cash, what about the potential for buybacks? “Clearly that’s one of the factors that I think leads to the equity market continuing to do well next year against the backdrop of what I think will be a squeezing margin environment is companies will deploy that cash towards buybacks to hold up shareholder value. Because after all, that’s how CEOs are paid in this country.”

Read on and watch the video and share with me your take on the markets at jmakris@investorplace.com

Joanna Makris: Let’s get into your thoughts on Q4. Obviously, from a stock market perspective, we are seeing a sector rotation into stocks more positively exposed to rising interest rates, abating fears on omicron… What are your thoughts on Q4 and what stocks are going to look like as we close out the year?

Steven Ricchiuto: That’s a great question. We upgraded our growth number for Q4 to 6% from 4%. We did it well before the payroll employment numbers. In fact, we did it on the backdrop of evidence that there was an early rush in holiday spending. And that will lift the fourth quarter average relative to the third quarter, which was depressed, again, due to a lack of consumer spending. So we think that early rush in spending — along with what turns out to be a fairly significant decline in the trade deficit in the month of October — suggests that we are going to have a nice pick up in economic activity, therefore that 6% level.

Our forecast for 2022, however, is that we are going to gradually slow down from this level. And by the end of next year, we’ll be looking at growth rates closer to 2 to 2.5% on average going forward. I mean, our actual specific forecast are for first quarter growth to be 4%, our second quarter growth to be 3%, our third quarter growth to be 2.5 and our fourth quarter growth number for next year to be 2.25%.

As we think about GDP growth, what do you think are the key catalysts for reacceleration next year?

The deceleration that we’re going to get in 2022 is a function of expectations of higher short-term rates i.e. the Federal Reserve tightening monetary policy. The market’s already doing a lot of that for them. That’s why the yield curve has been flattening, or I should say the spread between two-year treasury notes and 10-year treasury notes [has] been declining. That flatter curve environment then creates a less confident environment for corporations going forward. It also makes it harder for banks to make money in lending and therefore they pull back on their lending. So it creates an environment of a slower GDP area.

The stronger… or I should say the rising short-term interest rate environment then creates a rising currency. And a rising currency then adds to the deceleration in growth next year. And on top of all this, if Joe Biden gets the stimulus program — the version of Build Back Better that is incorporated or has been passed through the House of Representatives and is currently stalled in the Senate — it will actually be a net negative on the economy. Because the spending levels on aggregate are not much different than those incorporated in the American Rescue Plan, which was his first piece of legislation that got done last March. But he will have higher taxes. So those tax increases will lead to a slower economy going forward into 2022.

One area that’s been tricky to predict is the housing market, which you alluded to. What are your views looking into next year and [the] impact on economic growth?

Housing is not going to be negatively affected by interest rates in 2022. You [do] wonder whether or not rising prices leads to an environment where it reduces demand because people just simply get priced out of the marketplace. But I will warn you that there hasn’t been this big rush to building new product and bringing it to market.

That I think will happen in 2022. And I think that will lift the economy as actual construction put in place — dollars spent in the economy — actually go up on new construction as opposed to everyone running out and buying existing product.

Labor [is] another major concern across a number of industries. What’s your view on the labor outlook and impact?

Well, everyone’s talking about the strikes. Everyone’s talking about the fact that wages are going to go up in 2022 because of the scarcity of workers relative to jobs. I think a lot of the jobs that are currently counted as open will disappear. I think they’re permanently gone. I think as people reset their business outlooks going into 2022, we will discover that we were holding onto a lot of jobs in our totals of openings that were pre-Covid. I don’t think all those jobs are coming back.

So I think this job opening versus job hiring or hiring divergence that’s been happening will basically correct itself from both ends in 2022, rather than being corrected all from one end. And therefore, I think it’s going to be hard for labor to make back all of the reduction in their purchasing power that’s come as a result of higher prices.

Supply chain. Obviously a number of companies are talking about those concerns abating. We did see a decline in the auto sector last quarter. What are your thoughts? Are there any particular sectors that you think are more immune to disruption?

That’s a great question. I wish I had a good answer for you. I will tell you what I’ve noticed from our inputs… Companies are finding alternative ways to avoid the bottlenecks. It’s a little bit more expensive in many many of these cases — you have to go to different ports, have to truck product, you have to load it on trains, or you have to bring it in by air. All these factors are clearly weighing on the cost structure.

But again, I don’t think corporations are going to be able to pass all of this through to the consumer. I think at the end of the day, really what happens in ’22 is we have to sit back and recognize that a lot of the growth expectations that we have for earnings are going to be trimmed. Which means, yeah, 2022 will be a good year for stocks, but it’s not going to be as good a year as 2021.

At what point do rising oil prices derail [or] potentially slow recovery for next year?

Yeah. Oil prices and the nature of the economy. It’s interesting, we were able to grow fine with a $100 barrel of oil. We have become much more efficient as an economy in dealing with the energy environment.

I mean, an energy shortage, not just a price gain, would be a real problem. But we don’t seem to have those. You have those concerns in other regions. You don’t seem to have it here. Here it’s a function of price.

With all of these moving parts, what sectors do you think are really best-positioned for 2022?

You know, I really think the defensive positions — and I would put growth into a defensive position these days. Because growth has been behaving that way… The reality is, in an environment where you’re looking for where the economy’s going to do better, the transition that’s going to continue to take place where we substitute capital for labor, it’s really going to continue to benefit the growth sectors. And I think those are the areas that we will see continued value improvement next year.

As the year progresses, I do think the yield curve will re-steepen somewhat… The market does most of the tightening for the Fed. The Fed will not have to validate all of it. And the net result will be a steeper yield curve and some improvement in banks later in the year. But that’s really a second-half story.

Companies are also sitting on a ton of cash and we haven’t seen much in the way of dividends and stock buybacks. Do you think that’s going to change next year?

Well, clearly that’s one of the factors that I think leads to the equity market continuing to do well next year against the backdrop of what I think will be a squeezing-margin environment… Companies will deploy that cash towards buybacks to hold up shareholder value. Because, after all, that’s how CEOs are paid in this country.

Chinese stocks are on everyone’s mind. Obviously, [there’s] the Chinese internet ADRs, the selloff related to the Didi listing, potential tightening from the SEC. What’s your view on investor appetite for these stocks?

I think investors have been rotating out of them. I think they’re looking at what’s happening in China and they’re concerned. They’re beginning to come around to our view that China is heading to a much slower sustainable growth trajectory. And therefore, with the government ratcheting in their controls of a lot of these products that were previously very high flyers, I think there’s a rotation out of the market that I think will be permanent. I’m not saying people are completely walking away from it. But I think people have taken a good chunk of the money off the table in fear of what may or may not happen. And I think rightly so.

Their problem has been where do they go with it? I think initially some of it went into crypto. I think some of it’s come back into the U.S. market over time. I think some of it will go back into other emerging economies as well. So I think that money will be redistributed throughout the markets.

If you had to think about how is investing different in 2022, what are some of the forces that could be tailwinds and headwinds? What does it look like relative to what we saw in 2021?

I think in the first half of the year it’s all headwinds. Which was different than what we saw in 2021, when a lot of it was tailwinds. In the first half of the year, for next year, it’s all headwinds.

Then as the year progresses and we begin to recognize that the economy has slowed, the inflation numbers have come off the boil, wage numbers haven’t gone up as much, the Fed isn’t going to be forced to do as much — look for the currency to reverse, look for the interest rates to reverse, look for the yield curve to steepen and look for the equity market to be able to get beyond all the uncertainty and push back up towards higher levels as the year progresses.

What else are we missing in terms of the macro outlook? What else would you want to point out for retail investors?

At this particular juncture, I think we’ve covered just about everything. I mean, I don’t think energy is going to be a drag. I think fiscal policy will be a drag. But I don’t think we’ve missed anything at this juncture.

Your comments and feedback are always welcome. Let’s continue the discussion. Email me at jmakris@investorplace.com.

On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.

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