Outlook 2022: Beauty and the Inflation Beast?

By

Tanaya Macheel and Jesse Pound of CNBC report Dow jumps more than 200 points to record close to start 2022, Tesla boosts Nasdaq by 1%

Stocks rose on Monday as investors began the new year by betting the economy could overcome the latest surge in Covid cases and lifted two of their favorite stocks to significant milestones.

Apple shares gained to become the first company ever with a $3 trillion market valuation, and Tesla shares jumped 13.5% in a single day.

The Dow Jones Industrial Average rose 246.76 points, or 0.6%, to hit a record close of 36,585.06. The S&P 500 also notched a record close, as it gained 0.6% to reach 4,796.56. The Nasdaq led the gains, advanced 1.2% to hit 15,832.80.

Bond yields jumped to start the year with the 10-year Treasury yield topping 1.6%. That gave a lift to bank stocks, with Bank of America jumping 3.8%. Wells Fargo gained 5.7% after an upgrade from Barclays.

“It’s a glass-half-full start to the year and that’s been our perspective throughout 2021 and heading into 2022,” said Tom Hainlin, global investment strategist at U.S. Bank Wealth Management. “We’re still in that modestly optimistic outlook for the year ahead and think the economy and corporate profits are set up to support rising equity prices, at least in the first part of the year.”

Apple shares gained 2.5% to hit a new record and reach a $3 trillion market cap, becoming the first U.S. company to do so and tripling its valuation in less than four years.

Tesla helped generate some of the momentum Monday, jumping after the electric vehicle company reported 308,600 deliveries in the fourth quarter, beating expectations. Along with Tesla, big automakers also saw their shares climb. Ford Motor and General Motors rose about 4.8% and 4.3%, respectively.

Reopening stocks broadly pushed higher on Monday. Airlines rose as investors shrugged off concerns about holiday flight cancelations that have extended into Monday. American added 4.4%, and United gained nearly 3.9%. Norwegian Cruise Line and Carnival Corp were among the top gainers in the S&P 500, adding about 6.9% and 6.4%, respectively. Casino stocks were higher too, with Las Vegas Sands and Wynn Resorts were each up more than 3%.

Stocks have a tendency to gain in the start of a new year as investors look to put new money to work, Bank of America noted on Monday. The S&P 500 was up in the first week of the calendar year in 11 of the last 13 years, with an average gain of about 1.6%, the firm found.

Monday’s moves come after markets closed out a strong 2021 last week. The S&P 500 rose nearly 27% for the year, with the Nasdaq Composite and Dow also posting large returns. Stocks fell slightly on Friday, but the S&P 500 and Dow were positive for the final week of the year.

Still, uncertainty around the Covid-19 pandemic remains for the start of the year. The rise of the omicron variant helped lead to thousands of flight cancellations during the holiday season and has led some businesses and schools to consider temporary closures. Also, several major Wall Street banks have asked employees to work from home for the first few weeks of January.

While the fast spread of the omicron variant has been reflected in case numbers, data shows it hasn’t led to a major increase in hospitalizations, and investor appetite for vaccine makers has been subdued. They were among the biggest decliners Monday, with Moderna and BioNTech down about 7.4% and 10%, respectively. Pfizer fell 4%.

“Every single wave that we have of a new variant, we get over faster, and I think that will continue to happen,” Liz Young, SoFi’s head of investment strategy, told CNBC’s “Halftime Report” Monday.

Infectious disease expert Dr. Anthony Fauci told ABC’s “This Week” on Sunday that U.S. health officials may soon update guidelines to include a testing recommendation to signal when a person who previously tested positive for Covid can leave isolation.

Indeed, inflation, monetary and fiscal policy will be key themes to watch this year. 

Let me begin by wishing everyone a happy & healthy new year, all the best for 2022!

This year's outlook is really a continuation of themes I've been tracking going into year-end, namely, is inflation stickiness going to persist and if so, what are the chances the Fed makes a monumental policy mistake?

Let me just state off the top, I don't see the Fed making a policy mistake, raising rates aggressively, even if inflation expectations rise further, so from this point of view, it should be fine for risk assets.

If today's price action in the stock market was any indication, there's still plenty of liquidity out there and global investors can't get enough of US stocks. 

On the health front, Omicron is so contagious that many vaccinated and unvaccinated are testing positive, so natural immunity is forming. 

At least it seems to be a much milder disease and if more people get booster or get infected, we will reach herd immunity:

That boosted reopening stocks today but the sheer volume of Omicron cases is proving to be difficult and threatening healthcare systems all over the world.

But once this Omicron tsunami passes, and it will pass, we have a lot to look forward to and the market is definitely signaling better days ahead. 

Can there be a fifth wave? Sure, it's possible but the truth is the natural course of viruses is even though they become more transmissible, they typically become less lethal. 

Not to mention, we have new treatments and better testing so in theory, we should be better prepared for each new wave.

So, if Omicron wave passes by and the US and world economy continue to strengthen, then what does that mean for rates, stocks and other risk assets?

The consensus is this:

  • Inflation pressures should subside but inflation will remain at historically high levels 
  • The Fed will raise rates at least twice this year and possibly a third time
  • Bonds will continue to underperform and stocks will outperform but at a muted pace

In his outlook for 2022, Economic Whiplash, Francis Scotland, Director of Global Macro Research at Brandywine Global notes this:

The defining characteristics of the economic outlook for 2022 could be more about the composition of global growth than its trend. As long as the threat persists, a return to normalcy from pandemic trauma still seems off in the future rather than around the corner. However, some of 2021’s more anomalous economic developments look set to ease, which is encouraging for an extension of the global expansion into 2022. If these anomalies were to reverse completely, which is not impossible, the outlook might even start to look like a case of economic whiplash.

The biggest anomaly of 2021 was inflation. Global in nature, the extraordinary surge in prices was caused by supply chain disruptions and strong policy stimulus measures in the developed world. American programs supporting income and demand were the most aggressive in the world. Correspondingly, the U.S. was the only major economy to see nominal personal consumption eclipse its pre-pandemic trend with inflation reaching 30-year highs. In contrast, the rebound in European nominal spending remained short of its pre-pandemic trend, and core European inflation moved relatively modestly to about 2.5% from 1%. Marching to a completely different drummer, China’s economy decelerated all throughout 2021 as its policymakers took advantage of the U.S.-led global rebound to crack down on domestic property sector leverage. How the economic giants reacted to the ebb and flow of viral infections only seemed to exacerbate the extremes: China’s tendency to shut down factories and production colliding with government-supported U.S. spending.

A number of factors suggest 2022 could be very different. The worst of the supply disruptions may be over. Order backlogs are improving, inventories are growing again, and executives of key supply-compromised industries are sounding more optimistic. U.S. households may be shifting their consumption back to services after a nearly two-year hiatus, supplanting the online binge of consumer durable goods that—along with higher food and energy prices—drove the bulk of the spike in inflation. Rising prices have slowed real consumption and energy costs remain a headwind. Asset inflation supports consumption, but U.S. monetary policy is turning hawkish. On the other side of the world, Chinese macroeconomic policy is only starting to turn dovish.

What do these trends imply for 2022?

  • Based on surveys, many investors expect to see U.S. inflation retreat next year but only to a level that remains well above the Federal Reserve’s (Fed) inflation targets. The surprise could be a bigger drop. If so, global nominal gross domestic product (GDP) would slow significantly while real GDP growth remains firm or even edges higher, bolstered by continued re-openings and stabilization in China.
  • The composition of global growth could shift as well—less U.S. and more rest of the world. Domestically, the pivot would be from goods to services.
  • Instead of fretting about the Fed being too stimulative, the risk in this scenario is the U.S. central bank putting on the brakes too hard just as inflation retreats. Alternately, the Chinese authorities might not stimulate hard enough in order to ease through the country’s property market setback.

The U.S. mid-term elections and geopolitical hot spots are all added risk factors. In particular, determined compliance with ESG goals on the part of countries and companies could sustain upward pressure on oil and gas prices, leading to another version of 2021’s supply shock. However, Omicron’s arrival as the latest mutation in the COVID pandemic is another reminder that the biggest uncertainties in the outlook are the virus itself and how people and policymakers react. Embedded in the base case is the assumption that the pandemic evolves into more of an endemic that the world learns to live with.

I encourage my readers to read Brandywine's outlook for 2022 here as it is excellent. 

In his credit outlook, Brian Kloss of Brandywine notes this:

“Given expectations for a vaccine and the tremendous policy responses at work, we see a very high likelihood of a cyclical recovery” was how we started this commentary a year ago in December of 2020. It does feel as if we could start this year’s commentary with a similar outlook. That being said, looking out to 2022, one can expect some events to be similar while others are going to be quite different. Vaccines, therapeutics, Delta, Omicron, Pfizer, Moderna—the list of pandemic nomenclature goes on, and all these terms will continue to be focal points for markets as we as a global community continue to deal with that virus we all wish we could forget—COVID-19. As we move into the third calendar year managing and living with COVID, markets continue to adjust and adapt as scientists and policymakers continue to make significant inroads, all while the virus eventually moves from a pandemic to endemic.

However, the unprecedented monetary and fiscal policies we discussed last year are now transitioning to the next stages as the role they played during the pandemic begins to revert back to a more “normal“ or conventional policy. Fiscal policy will be expansionary but nowhere near what the markets saw in the previous two years. Meanwhile, regulatory and tax burdens will be increasing. Most importantly, monetary policy will become more restrictive as the U.S. Federal Reserve embarks on ending its quantitative easing program, possibly on an accelerated basis. Embarking on tapering first will allow Fed policymakers to assess market conditions before they move to raise the federal funds rate. These tightening conditions should arrest the spread tightening that we have seen in corporate credit over the last eighteen months. However, economic conditions should remain supportive of credit spreads, and we anticipate minimal defaults across global credit assets.

While they may not rise to the extent of 2021’s record-breaking year, corporate profits in 2022 should continue to surprise to the upside, especially in the first half of the year. There are two strong tailwinds working in their favor and supporting the market heading into the new year. First, supply constraints may have peaked, which should relieve cost pressures across multiple sectors. Second, companies continue to exhibit a high degree of pricing power due to strong demand from consumers. Consumers, in aggregate, possess an enormous amount of savings ready to deploy as the economy continues to renormalize. The second half of the year becomes a bit murkier as global central banks may become less accommodating if inflation persists.

Therefore, we remain constructive on risk assets, expressing that view across corporate credit markets by utilizing our strong, proprietary underwriting model and deploying a very nuanced allocation to select credit instruments. Our focus continues to be on basic industries, capital goods, energy, and other cyclical sectors in both developed and emerging markets. We favor those industries that have a more cyclical tilt, like autos and mining, which should see marked improvement as the economy rebounds from the lockdowns but will be very mindful to the risks we discussed above around tightening monetary and fiscal conditions. Similar to last year, we believe higher-quality assets offer the best risk/return profile and should remain supported even if there is risk around monetary policy. We are generally avoiding both ends of the credit-quality spectrum, with high quality offering limited total return potential, and lower-quality bonds still susceptible to hiccups in the global economic recovery.

And in the outlook for equities, Patrick Kaiser and Celia Rodgers of Brandywine note this:

U.S. equity markets saw a strong year in 2021. However, the big surprise was that large-cap growth style stocks again outpaced value, driven by sizable outperformance in the latter part of the year as COVID fears re-emerged.

Here are some of the major themes we anticipate in 2022:

  1. Fed Boost for Financials: We expect the Fed to raise rates over the next 12 months. This view makes us positive on financials. At the same time, as stimulus pulls back, we expect loan growth to return, which should favor our bank holdings. The longer inflation continues without moderating, the more aggressive the Fed will need to be in its reactions. Our base case is that inflation will continue above the Fed’s 2% target through the entire year, suggesting the backdrop is now more structural for inflation than simply transitory.
  2. U.S. Growth Continues: We expect the U.S. economy to show solid growth, driven by continued “reopening”, strong auto production, inventory rebuilding across a number of industries, infrastructure spending, and pent-up demand generally. Consumer and commercial balance sheets are in great shape.
  3. Supply Chain Bumps Even Out: Near term, the ongoing progression of the COVID pandemic continues to be impossible to predict, and we believe flare-ups globally will lead to intermittent government responses that drag on local economies, mostly outside of the U.S. Antiviral pills should help in the coming months. Impacts will likely linger with the supply chain issues improving over time, albeit with bumps. Hopefully, normalization will be visible by the second half of the year.
  4. Equity Valuations Flash Warnings—and Opportunities: The equity market, broadly speaking, looks overvalued with faster-growing companies appearing expensive. In particular, there are many companies with good-sized market capitalization but without earnings or positive cash flows. These companies offer inflated valuations based on unconventional metrics and promises of earnings in the longer term. Furthermore, these stocks represent a significant share of core index weights, which suggests a challenging year might be in store for broad market indices. Value and small-cap stocks do not have the same hurdles to overcome since cyclicals and companies positively correlated with higher rates are generally trading with much lower expectations and valuations.

On a forward earnings basis, the Russell 1000 Value Index is trading at a steeper discount to the Russell 1000 Growth than it did at the peak of the pandemic (see Chart 9). We believe this sharp discrepancy in valuations makes a strong case for value stocks in 2022.


Now, did you catch the part of there are many companies with good-sized market capitalization but without earnings or positive cash flows and these stocks represent a significant share of core index weights, which suggests a challenging year might be in store for broad market indices?

Today, Dimitri Douaire,  CIO of Patrimonica, posted this comment on Linkedin in response to this article on how as the ETF world booms, so do the risks:

Low cost passive ETFs have rightfully gained market share in the past decade. But since the allocation scheme for most of them is predicated by market capitalization, I keep wondering what would happen to ETF performance relative to actively managed funds if US legislators broke partisan lines and decided to curb the influence that big tech has on the social fabric. This could cause the most heavily weighted companies in the indices to underperform quite dramatically for a prolonged period. This would leave passive investors overexposed to the worst performing cluster of stocks. In Canada, we have seen this story happen thrice in the past 20 years: Nortel, Research In Motion and more recently Valeant which had their boom and bust episodes.

Similarly, what would happen to ETF performance relative to actively managed funds if oil prices doubled from here now that the energy sector is just a fraction of what it was a decade ago, leaving passive investors largely unexposed to the best performing sector under such a scenario.

The goodwill accumulated by the passive industry would be impacted because whether it realizes it or not, it has indirectly benefited from the sustained momentum that a few stocks have enjoyed.

Indeed, there are risks in passive investing but you wouldn't know it on a day like today:

It's also worth noting that it wasn't a handful of stocks driving the market to record highs last year:

So, with all these crosscurrents, where should investors invest this year?

Before answering this, let's look at the S&P sector performance last year:

As shown above, all sectors returned double digit gains but only Energy (XLE), Real Estate (XLRE), Technology (XLK) and Financials (XLF) outperformed the market.

Defensive sectors like Utilities (XLU) and Staples (XLP) underperformed the overall market.

Nevertheless, Morgan Stanley is keeping its defensive tilt even if it recommends bottom fishing stock losers:

U.S. stock investors can “add some more spice” to their choices as a new year begins and the pressure of keeping up with indexes eases, according to Morgan Stanley strategists.

“As we enter 2022, the key question for investors is to decide if they want to stay with the relative winners, or is it time to start bottom fishing the losers,” strategists led by Michael Wilson wrote in a note to clients on Monday. “While we continue to favor the large cap defensive tilt that has been working, we recommend creating a barbell with stocks that have already been hammered but offer good prospects at a reasonable valuation.”


Following a year of blockbuster gains and earnings growth for U.S. stocks, most strategists now expect more muted returns in 2022.

That’s because they see the post-pandemic economic rebound as past its peak, while the Federal Reserve hits the brakes on stimulus measures that fueled the rally. Beating benchmark indexes has also become more challenging as the rally narrows, with most of the gains concentrated in a handful of mega companies in the S&P 500.

“We still recommend a large cap defensive bias given tightening financial conditions and decelerating growth,” Morgan Stanley’s strategists said on Monday, singling out real estate, healthcare and consumer staples as potential winners against the emerging macroeconomic backdrop. Opportunities also exist elsewhere, such as small and medium-cap value stocks, they said.

“Despite the quality bias since March 2021, small cap value has outperformed small cap growth by 25 percentage points--the mirror image of large,” the strategists wrote. “That is some serious alpha, and we think it’s related to our other key view--valuation matters.”

We shall see if valuation matters but one thing is for sure, last year was an odd year and most of the top performing stocks weren't being driven by valuation but by short squeezes and momentum:

With the Fed tilting to a more hawkish stance this year, it's sensible to think rates will rise and that will continue to weigh more on growth stocks than value stocks, especially hyper-growth stocks that got clobbered during the second half of last year:


A lot of sector calls depend on where you see rates next year.

The big asset managers are bracing for more losses in Treasuries:

And long bond prices are plunging as yields back up:


Talking to a friend of mine earlier, he sees the yield on the 10-year Treasury note hitting 2% by year-end and he may be right.

In fact, if inflation expectations continue to climb higher and growth picks up significantly, you might see rates back up closer to 3% where they were back in October 2018:


Of course, the speed of adjustment or "rate normalization" matters a lot for risk assets because an abrupt increase in rates will clobber risk assets. 

If, however, rates gradually rise, then investors should remain favorable to cyclical stocks, especially financials:

Conversely, if you feel rates will peak soon and tumble again, then it's time to bid up growth and hyper-growth stocks.

If you look at mega cap growth stocks, the uptrend is intact and bullish:

But keep your eyes peeled on rates, any abrupt backup in bond yields and growth assets will get hit.

And if it's really abrupt, all market sectors will get hit but more defensive sectors like Staples (XLP) or Healthcare (XLV) should fare better:


Picking sectors is no easy feat which is why most investors just stick with the S&P 500 ETF (SPY):

The uptrend there looks great but I expect several dips throughout the year which is why I'm looking at important levels like the 20 and 50-week exponential moving averages.

In terms of reopening stocks, they will bounce but there's nothing to get too excited about at this time:



I would also caution investors not to rush in and buy Chinese internet stocks even if they're way oversold:


I'm sure some big hedge funds are snapping these stocks up here while others continue to short them.

Anyway, it's a great start to the year but there are a ton of financial and geopolitical risks that can throw this market off. 

What concerns me right now is Europe and China and as Jeffrey Snider of Alhambra Investments points out in his latest comment, there are echoes of 2018 and a growth scare remains a very real possibility in the latter half of the year:

We shall see but I remain long USD, short euros and "shortish" on the CAD (will be range-bound):



Alright, let me wrap it up there, once again, I wish everyone a happy & healthy new year.

I'll be back next week but looking forward to Friday's employment report and market reaction following it. 

Below, Liz Young, head of investment strategy at SoFi, and Steve Weiss, chief investment officer and managing partner of Short Hills Capital Partners LLC, join the 'Halftime Report' to discuss their market outlook for 2022. Liz Young also discusses her top stock picks for 2022.

And Tom Lydon, ETF Trends CEO, joins the 'Halftime Report' to discuss what to watch for in the ETF market during 2022, stating he wouldn't bet against Cathie Wood's high-tech names.

Lastly, Tom Lee of Fundstrat on how to trade the markets in 2022. With CNBC's Melissa Lee and the Fast Money traders, Guy Adami, Tim Seymour, Karen Finerman and Dan Nathan. 

Update: Yahoo Finance's Brian Sozzi sits down with Jeffrey Gundlach to discuss the future of the bond market, China and signals in the market for an upcoming recession in this Yahoo Finance exclusive teaser. 

Gundlach believes the bond market is suggesting an economic slowdown is in the cards this year. And as such, the yield curve is a must watch for investors right out of the gate.

Adds Gundlach, "I think the bond market is already showing enough of a recession indicator that by 2023 it's seems pretty likely. And, like I said earlier, I don't think a lot of Fed officials, economists and investors appreciate the fact the economy keeps buckling at lower and lower interest rates. So I think the Fed only has to raise rates four times and you're going to start seeing really a plethora of recessionary signals. I think it's certainly a non-zero probability that you get a recession in the latter part of 2022. That's going to be dependent again on how aggressive the Fed is. One thing that we did notice in 2018 is the Fed stopped QE, they started quantitative tightening — letting the bonds roll off. And then they started raising interest rates and we got an instantaneous bear market." 

Comments

Post a Comment