2022 Stock Market Forecast Brings Unfamiliar Risks For Investors

The S&P 500 rose 29% in 2019, 16% in 2020 and another 27% in 2021. Is another big gain too much to ask for 2022?


The 2022 stock market forecast looks considerably different than 2021. To achieve another big year, the market will need to tame new risks, some that investors aren’t accustomed to. Key among these is inflation — a sore that had not flared up on the market’s skin since the 1980s.

The 2021 market rose on low interest rates, government stimulus and a huge rebound in earnings. The new year starts with the Federal Reserve moving toward the first rate hike since 2018 to tamp down inflation. In Congress, there’s no clear path for another massive spending bill. Earnings are expected to grow, but more moderately.

Lacking the same drivers of 2021, the stock market will need different protagonists.

Big Stocks Dominate Market

More and more, the stock market is becoming defined by the five or six largest companies in the S&P 500. The six largest — Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon.com (AMZN), Meta Platforms (FB) and Tesla (TSLA) — today account for nearly 25% of the total index. The Nasdaq is similarly top-heavy, with its six largest holdings representing more than 40% of the index.

A Goldman Sachs study found that most of the stock market’s gains since April came at the hands of just five major tech stocks: Apple, Microsoft, Nvidia (NVDA), Alphabet and Tesla. Analysts believe investors have turned to the relative safety of a few huge and profitable stocks to withstand the multiple and sometimes unpredictable risks hitting the market.

Sean O’Hara, president of Pacer ETFs, told IBD that a few companies have dominated market returns for a long time, with the S&P 500 return driven almost entirely by five or 10 names. But O’Hara believes that’s likely to change in 2022, with excess returns coming from stocks that have underperformed or lagged the top 10.

Earnings, Sales, Margins For 2022 Stock Market Forecast

If the indexes climb again in 2022, the economy and corporate fundamentals would be big reasons.

Most economists expect a slowdown from 2021, but continued expansion. IHS Markit forecasts GDP to grow 4.3%, down from an estimated 5.6% in 2021. Truist and LPL Financial forecast 4% to 4.5% growth for 2022. Wells Fargo expects 4.5%.

New waves of Covid-19 won’t derail the recovery, Markit’s economists say. The emergence of the omicron variant signals a transition from pandemic to endemic. Shipping disruptions, supply-chain troubles and energy price increases will fuel prices in the first half of 2022. Inflation rates, it adds, will slow by the end of 2022.

S&P 500 earnings are expected to grow 9% in 2022, according to FactSet. That’s well above the 10-year average of 5% but much cooler than the 45% surge estimated for 2021. All S&P sectors are projected to increase earnings, except finance, which is on track for a 8.9% drop in EPS based on analysts’ estimates. Industrials should lead with a 45% surge in earnings. The consumer discretionary sector sees 32% growth, while energy earnings should jump 28%.

FactSet’s calculations put 2022 revenue growth of the S&P 500 at 7.3%, more than double the 10-year average of 3.5%. Industrials, consumer discretionary and energy sectors share the best sector estimates for sales. The forecasts seem to reflect strength in cyclicals as the economy continues to rebuild from the pandemic.

Even more impressive is the S&P 500’s profit margin forecast, which is projected to be 12.8%. Despite concerns about labor shortages, higher inflation and supply-chain disruptions, it would be the highest net profit margin since FactSet started tracking the metric in 2008, says John Butters, senior earnings analyst. Preliminary 2021 profit margin is 12.6%.

But by sector, margins could vary a lot. Real estate, technology and financials could see margins top 15%, while energy, consumer discretionary and consumer staples margins will be under 10%.

Inflation And The 2022 Stock Market Forecast

“Inflation is, of course, the wild card that makes the usually mundane modeling of next year’s revenues and margins much more difficult,” Nicholas Colas, co-founder of DataTrek Research, wrote in an analysis. That 7.3% rise in sales is a big number for the third year of an economic expansion. But add into the mix possible 4% inflation, and real growth shrinks to 3.3%.

Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Global Research, says companies have done well managing margins despite higher costs, finding success in passing on costs to consumers while increasing efficiency.

Still, Wall Street never likes to part with cheap borrowing rates.

“Any time the Fed begins a rate hike cycle, the equity market gets jittery,” Kelly Bogdanova, vice president and portfolio analyst at RBC Wealth Management, told IBD. “This is despite the fact that the S&P 500 has historically performed well in the period surrounding the first Fed rate hike.

“Could the Fed spoil the party? Yes — eventually. But before that happens, monetary conditions would have to transition from ‘easy,’ what we have now, all the way to ‘tight,’ which is some considerable distance down the road.”

Based on Fed funds futures, there’s a 50% chance that the first rate hike will come at the March Fed meeting. There’s also about a 50% chance for a quarter-point increase in April, with 17% odds of a half-point hike. A majority of policymakers predicted three Fed rate hikes in 2022.

The asset of choice in 2022, as it was in 2021, will be equities, Bogdanova adds. That’s not just because monetary tightening is farther off but also because massive Covid stimulus is still pumping growth and should persist for a couple years. Also, pent-up demand should keep household spending going, while businesses rebuild inventories and boost capital spending. Bogdanova sees no sign of recession.

The 100 Best Stocks Of 2021

What Works In Higher Inflation

Stocks tend to perform badly when inflation runs hot, but some sectors have historically performed better in such climates, says a study from Hartford Funds covering 1973 to 2020.

The energy sector beats inflation 71% of the time and delivered an annual real return of 9% per year on average. Sector revenues are tied to energy prices, a key part of the inflation picture.

Equity real estate investment trusts outperform inflation 67% of the time and post an average real return of 4.7%. Equity REITs can pass-through price increases in rental and property prices. Consumer staples, utilities and health care outperform to lesser degrees.

In financials, high inflation can hurt banks because it erodes the present value of current loans that will be repaid in the future.

Market Timing And The 2022 Stock Market Forecast

Investors can drive themselves crazy interpreting economic forecasts, analyst views and other information. But the best guide of the market is the major indexes themselves. IBD’s market timing method helped investors stay in tune with the latest turns.

But 2021 saw a lot of short-term moves. For example, a Jan. 22 sell-off put our market outlook at “uptrend under pressure,” but the outlook was back to “confirmed uptrend” two days later.

Overall, IBD’s market outlook was correct. Currently, the IBD outlook sees the market in a confirmed uptrend despite volatile trading. The Big Picture column, a daily analysis of market action, shows the current outlook and spells out the reasons for it.

Keep an eye on the advance-decline lines of the NYSE and Nasdaq, found in IBD’s General Market Indicators page. The Nasdaq’s line peaked in February and is diverging lower from the index. Why is that important? A cumulative A/D line lagged for months in 2000 and 2007 — before two major bear markets.

Trends For 2022 Stock Market Forecast

With the S&P 500 reaching a third straight year of double-digit gains, the odds are good for a fourth year of 10%-plus growth. That’s because when the S&P 500 makes three-year strings of double-digit years, the next year sees an average return of 8.4%, says Jessica Rabe, co-founder of DataTrek Research.

But the returns vary widely. In four up years, the average gain was 25.8%. In the four down years, the average decline was 7.2%. So when the down years come, stock moves are more moderate.

The stock market’s 2022 performance “will largely stem from how the market discounts 2022’s economic growth and U.S. corporate earnings given the Fed’s now hawkish messaging,” Rabe added.

In its 2022 forecast, LPL Financial saw the U.S. economy in a midcycle expansion. In 30 midcycle years the firm identified, the average S&P 500 increase was 11.5%, with 80% of those years ending with gains.

Sector Rotation In The 2022 Stock Market Forecast

The strength in the main indexes in 2021 belied weakness in a number of sectors, sometimes deep enough to be considered corrections of their own. This shifting made it difficult to sustain gains in growth stocks. The IBD 50 rose 13.9% in 2021, a pronounced lag of the major indexes.

Sector rotation is a normal part of the stock market, but in 2021 moves could last only a few weeks or even a few days. Investors moved from one area to another as if they were afraid to lose gains. The year saw its fair share of breakouts that failed, and once-promising moves that were short-lived.

In this environment, it was essential to stick with the buy and sell rules IBD offers. Cutting losses short at 7% or 8% prevented larger damage in many cases. Buying at proper buy points off sound chart patterns should have kept investors off premature entries. In some cases, trend lines that offered earlier entries worked out better than traditional buy points. And action at important moving averages helped investors navigate the choppy seas.

So, will the frustrating sector rotation continue in 2022? That’s hard to say, but it is definitely a risk.

There’s been a significant amount of churn beneath the surface, says an analysis from Charles Schwab. Despite the indexes’ strong gains, most of their components sold off at some point. In the S&P 500, 92% of stocks fell at least 10% sometime during the year. The average drop was 18%. In the Nasdaq, 89% of components saw 10% drops, for an average decline of 40%. And 98% of Russell 2000 stocks saw 10% declines, with an average loss of 36%.

“Although these rotational corrections are preferable to watching the bottom fall out all at once, there is a risk that the major stock indices at some point will reflect more of the weakness that has persisted under the surface,” the firm noted.

“Macroeconomic backdrops that include slower growth and tightening monetary policy tend to usher in higher intramarket correlations — that is, the potential for securities to rise and fall in tandem — as well as greater ‘tail risk,’ i.e., the probability that an investment will move more than three standard deviations beyond its historical mean.”

IPO Market And The 2022 Stock Market Forecast

The IPO market was a mixed bag in 2021, with record proceeds of $142.5 billion and the highest deal count in 20 years, according to Renaissance Capital. But returns were lousy.

A total of 27 IPOs raised more than $1 billion, the most in a single year ever, and more than 604 blank-check companies raised $143.5 billion in 2021. But as of Dec. 15, IPOs averaged a negative 10% return, the worst year in over a decade.

“The stars aligned for the IPO market in 2021 as deal flow and proceeds rocketed to record highs, and we do not expect to see the same level of activity in 2022,” the firm said in its year-end report. “Rising interest rates and new coronavirus fears have put investors on edge, and sky-high IPO valuations have come down accordingly.

“While slumping returns at year-end should make for a more cautious start to 2022, there is still a cause for optimism, since downturns often lead to quality IPOs sold at fair prices.”

The 2022 IPO calendar should stay busy with health care companies, including biotechs, medical devices and health services providers. With the U.S. consumer rebounding, Renaissance Capital expects a good number of retail and restaurant IPOs.

Some of the major companies expected to go public in 2022 are Greek yogurt brand Chobani, Brazilian steakhouse chain Fogo Hospitality and human capital platform Justworks.

Just one more factoid about IPOs: The 399 IPOs in 2021 was the highest deal count since 2000 — when the internet bubble bear market began.

Juan Carlos Arancibia is the Markets Editor of IBD and oversees our market coverage. Follow him at @IBD_jarancibia.


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