Robert Johnson, PhD, CFA, CAIA. Chairman and CEO at Economic Index Associates:
The biggest factor driving equity market returns during 2022 is Federal Reserve monetary policy. The near certainty of Fed tightening and rising interest rates in 2022 means that investors should lower their expectations for broad equity market returns. In Invest With the Fed (McGraw-Hill), my co-authors Gerald Jensen and Luis Garcia-Feijoo found that from 1966 through 2020, the S&P 500 returned 16.5% when the Fed was lowering interest rates and only 6.2% when the Fed was hiking rates.
Inflation was also markedly higher when the Fed was hiking rates versus lowering rates (4.5% versus 2.7%) so the difference in real returns to stock investors was even greater. The best performing sectors in a rising interest rate environment were equity REITs (10.3%), utilities (8.4%), energy (7.9%), and consumer goods (7.8%). The worst performing sectors in a rising rate environment were automobiles (-1.3%), durables (0.1%), apparel(2.8%) and retail (2.8%).
Emerging markets outperformed developed global markets during a rising rate environment. In rising rate environments, in US dollars, a market weighted emerging market index returned 9.9%, while the EAFE index returned only 2.7%. Finally, large stocks outperformed small stocks in a rising rate environment. The largest quintile of stocks returned 6.1% while the smallest quintile of stocks returned 4.6%.
Kunal Sawhney, CEO at Kalkine Media:
What may matter the most in 2022 is the appetite and sentiment of retail investors. There wasn’t a single month in 2021 when some or the other analyst was not warning about an impending correction or even a crash in the global stock market. Forecasters even prophesied a crash in housing markets and crypto assets.
But anything like this seems far from coming true. And one reason is the participation of retail investors. They have brought with them unprecedented liquidity to the market, which is driving growth in prices of stocks. Performance in 2022 will be determined by the sentiments of this class of investors. Should they continue using online discount brokers to park money in stocks, 2022 can be another record-setting year! A negative sentiment, however, can deal a severe blow and a major exodus of this class can bring down the indices from the heights they have peaked to in the recent past.
Patrick Wells, CFA. Portfolio manager & CFA at Pinnacle Associates:
COVID-19 tipped off a number of economic effects that are still developing, even as we enter 2022. It snarled supply chains, disrupted production, and shifted demand in unexpected ways. How we responded caused different issues. Governments around the world poured money on the problem: the Federal Reserve grew its balance sheet by $6 trillion, and Congress approved $7 trillion of spending. The combined result was the highest inflation seen in the US since the 1980s. The fundamental question is whether central banks can now correct a problem that was not wholly caused by monetary policy in the first place.
The biggest driver of markets in 2022 will be whether the Federal Reserve can effectively address problems to which it contributed but did not start, how Chairman Powell communicates the path of monetary policy, and to what extent tighter conditions will put a damper on economic activity. Transitions of this magnitude are seldom smooth. If the central banks do too much, tightening monetary conditions are likely to weigh on the market, especially on pockets of lofty equity valuations. If it does too little, inflation will erode company profits and consumer spending. There are many variables impacting financial markets today, but we expect that monetary policy will prove the farthest reaching.
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