Editor’s Note: Ali Shaff here, the Senior Managing Editor on John and Wade’s franchise. Please note that InvestorPlace will be closed Friday, Dec. 31. As such, we will not be publishing Trading Opportunities that day. Trading Opportunities will return on Monday, Jan. 3. Until then, stay safe and Happy New Year!
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This has been an eventful year; to date, the S&P 500 is up 23%, which is more than double the average for yearly returns. However, performance has been more mixed than it appears on the surface.
The higher risk index of small-cap stocks, the Russell 2000 Index, is up less than 8%. In a normal year, we would have expected small caps to do a lot better than the S&P 500, and that tells us investors are still risk-averse.
We expect 2022 to look a lot like 2021 because the factors that split the market and led to underperformance in many sectors in 2021 are expected to persist.
Valuations
Stocks have had incredibly high values this year.
The S&P 500 hit a price-earnings (PE) ratio of 38.8 in January, and it dropped back to 29 in December. However, 29 is still high and could be a problem for stock prices if long-term interest rates rise in the first quarter of 2022. The interest rate on 10-year bonds also crossed above 1% in January, and rising rates were a theme the entire year.
We don’t think rates are going to go back below 1% in 2022, but breaking above 2% in the summer seems likely. If correct, we will see mortgage rates rise and tech stocks fall unless economic growth is a lot faster than currently expected.
Shipping and Supply-Chain Issues
In March, a giant tanker named the Ever Grand blocked the Suez Canal for several days, which hindered an already-troubled supply chain.
This blockage was symbolic of what we experienced all year – and the situation has just started to untangle in the fourth quarter of 2021.
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In our view, the supply-chain issues that have caused economic problems are also a key factor driving inflation (less supply with more demand means prices rise).
As the supply chain smooths out in 2022, it should have a positive (or should we say negative…) effect on inflation rates and improved confidence.
The Federal Reserve’s Money Printing
The Fed’s meeting in March kicked off April’s rally in a big way.
Traders were ecstatic that the Fed planned to extend the easing and stimulus campaign indefinitely. Stocks jumped 9% in 31 trading days, which amounts to nearly 40% of the year’s gains. That story has changed with the Fed’s new policy of cutting back on stimulus and it will end in early 2022.
This will probably put some pressure on bulls, but we are cautiously optimistic that current growth rates can handle the change in the first quarter.
China Is an Unknown
In July, traders were shocked to see the Chinese government shift its focus from an emerging banking and real estate crisis to start laying down new regulations (and accompanying punishments) on big Chinese tech firms.
Stocks like New Oriental Education & Technology Group Inc. (EDU) and TAL Education Group (TAL) have dropped like rocks and have become almost un-investible.
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Risk of an economic slow down and more regulations on commerce in China is one of the biggest threats we will see in 2022. This is especially true for commodity stocks that are more directly affected by changes in China.
Earnings
Profits in the second and third quarter were so far above expectations that it will probably be the high-water mark for several years in the future.
Nearly 90% of the S&P 500 surprised to the upside, which is unheard of. This was great for investors in 2021, but it also sets expectations a bit high in 2022.
In a situation like this, we usually see a temporary negative reaction when companies start releasing an outlook for future quarters that is not quite as amazing as it has been.
We expect that issue to create some serious volatility in January 2022 when earnings are coming out again for the fourth quarter, however, in our view, this is going to be a buying opportunity than a long-term top in the market.
Inflation
In October, the push a pull between the fear of rising inflation and the Fed pulling back on stimulus took front and center. Prices rose quickly, but we have been stuck in a holding pattern ever since as traders try to price in the effect of inflation that has been trending at 6-8% over the last few months.
If the fundamentals don’t improve in 2022 this could make investing in tech stocks (very sensitive to inflation) more difficult.
Another Round of COVID
In November and December, the Fed started tapering, and COVID trends took a turn for the worse with the new Omicron variant.
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Fears of lockdowns, a slow fourth-quarter shopping season, and general uncertainty have contributed to volatility that we think will continue in the first quarter of 2022.
While we don’t yet see any evidence that this is as serious as the 2020 pandemic was, we do plan to remain very flexible and make changes if the outlook shifts.
The Bottom Line
In many ways 2021 was unprecedented.
The recovery was fast, but long-term solutions for the pandemic and supply-chain snarls have remained elusive.
Because economic and earnings growth rates are still very positive, we are optimistic about 2022, but investors should prepare themselves for a rocky ride through the first two quarters.
We’ll be back with you in the New Year with more trading opportunities. We’re glad to have you along for the ride!
Happy Holidays,
Sincerely,
John Jagerson & Wade Hansen
Editors, Trading Opportunities
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