After markets record some of the biggest gains of the past 20 years in 2021, what can investors expect?
History suggests that momentum should continue into 2022, but investors could also be further stressed in the coming year from a range of concerns over the coronavirus, inflation and interest rates, and politics, foreign and domestic.
As such, you hear a lot of Wall Street experts talking about the need for caution and realistic patience. Markets, they say, will have a good year, but they will be volatile. Perhaps not as volatile as early 2020, when panic over COVID-19 squeezed it by 35% in about a month.
However, that is not the case now. The SPX started 2022 by closing at a record high of 4,796.56 on the first day of trading.
That happened after the 2021 broad benchmark ended at 4,766.18, up 26.9% from 2020, the best performance since 2019, the third best performance since the 31% gain in 1997.
The increase of 18.8% in 2021 and the added 21.4%.
The fact is that the US stock market has played a sustainable role since the financial crisis of 2008-2009.
The S&P 500 has closed year 10 out of the past 13 years, and in the years it didn't finish higher, it ended the year flat.
There are many reasons to think that this series can continue.
The domestic economy is growing. Consumer spending is generally strong. Employment is on the rise, and the Department of Labor is expected to report on Friday that employment grew by 400,000 in December, falling from 4.2% to 4.1%.
Corporate profits, the real fuel for stock prices, are booming. Third quarter earnings were 27.1% higher than a year earlier, and it would take a big shock to derail the trend.
Tech stocks are still the players in the market. Apple (NASDAQ:) briefly had a market cap of $3 trillion Monday afternoon. Before markets opened, Tesla (NASDAQ:) gave investors a happy shock by announcing that deliveries for 2021 were up 87% from 2021 to 936,000. Analysts had expected 897,000 deliveries. The company produced 932,000 vehicles last year, half of which were at its factory in Shanghai.
Tesla shares were up more than 13% from Monday's close, peaking between the S&P 500 and stocks. The EV carmaker's shares are up 50% in 2021.
Its market cap approached $1.2 trillion, fifth among US companies, after Apple (whose market cap at the end of the day was $2.99 ??trillion), Microsoft (NASDAQ:), Google parent Alphabet (NASDAQ: ) and Amazon (NASDAQ:).
While the COVID-19 pandemic is proving to be persistent, current research suggests that the Omicron variant, which made its appearance around Thanksgiving weekend in November, could be a milder form of the virus. In fact, Scott Gottlieb, former Commissioner for the Food and Drug Administration, told CNBC Monday that Omicron may become less of a threat in a few weeks.
If the research is correct and people continue to vaccinate, he added, COVID could pose much less of a threat by the fall. In the future, he suggested, Americans will receive annual COVID injections, just as they do now for the flu.
But there are still many risks. These include:
1. Rising Interest Rates
The Federal Reserve believes it is time to relieve the US economy of the massive amounts of cash it has pumped into the economy since 2020 to prevent it from freezing. Since then, however, inflation has become a problem. Petrol prices have risen by almost 50%. Freight rates, food prices, new and used car prices have risen. Workers have demanded higher wages and can support their demands by leaving their jobs.
The most immediate tool the Fed has to fight inflation is to raise interest rates, which would help solve a second problem. The Fed's Federal Funds rate (the rate it wants banks to charge each other for short-term loans) is basically zero and has been since the COVID outbreak. Fed policy has contributed to the stock market rebound that began in the spring of 2000. It has also led to the sale of new and existing houses and the purchase of houses and apartments by major investors.
The central bank is expected to start raising interest rates in the fall, two or three hikes this year.
Bond yields rose on Monday, essentially in anticipation of higher yields. The wild tracked hit 1.628%, the highest yield since a peak of 1.746% on March 31.
So, is a rate hike the end of the world? Not immediately. But a rate increase campaign needs to be managed carefully. The Fed began raising interest rates in 2003 after cutting them sharply to help the economy weather the effects of the 9/11 terror attacks. It took three to four years for them to start weighing the markets and contributing to the 2008-2009 crash.
2. Richly valued stocks versus rising prices
Of the S&P 500 stocks, 434 ended the year higher in 2021. Of those, 96 were up more than 50% year-over-year, along with 23 stocks listed on the 30-component Dow Index.
In addition, 74 stocks ended the year higher.
Both vaccine maker Moderna (NASDAQ:) and cybersecurity software and hardware provider Fortinet (NASDAQ:) were up more than 100% for 2021.
Apple gained 34% in 2021 alone and was up 2.5% on Monday. NVIDIA (NASDAQ:), whose chips power video games and the systems used to run cryptocurrency networks, added 125%.
At the same time, many smaller stocks failed to match the ostentatious returns of their bigger brethren. Worse, the number of stocks hitting new highs lagged behind those hitting new lows as the year progressed.
As such, the risk is this: if interest rates get too high (say +5%), stocks will react badly. That's what happened during the market explosion of 1987; it also made a significant contribution to the 2008-09 financial crisis.
3. Continued inflationary pressures
These are not going away yet and will weigh on stocks.
These appeared after the outbreak of the COVID-19 pandemic in 2020, which disrupted the global trading system so much that no one could predict when a shipment of goods – from chips and electronic assemblies to cars and even the manuals that be used in the kitchen cabinet mounting – could actually be delivered.
Another inflationary driver: people left their jobs en masse during the pandemic, forcing employers to raise wages to keep hiring.
An additional catalyst: OPEC and friends have reduced global inventories. As a result, retail gasoline prices in the United States increased by 45% in 2021.
4. Stubbornly holding on to COVID-19
Remember last spring there was a brief global relief that the pandemic numbers were on the wane and maybe you didn't need to put on a mask? That came to a halt thanks to the worldwide spread of both the Delta and Omicron coronavirus variants.
Omicron appeared in late November and spread so quickly that reopened Broadway theaters had to close almost immediately, restaurants saw business dwindle abruptly, and cruise ships seemed unable to prevent the virus from infecting passengers and crew.
Shares of Red Robin Gourmet Burgers (NASDAQ:), a casual eatery, doubled in the first quarter in hopes the worst was over.
But inventory fell 30% in the third quarter and another 28.3% in the fourth quarter as customers were wary of dining in restaurants due to COVID concerns.
5. Global tensions escalate
With Russia's plans for a larger part of Ukraine, geopolitical tensions are mounting. China's interest in gaining control of Taiwan and Iran's pursuit of developing a viable nuclear weapon are adding to the headwinds.
Factor in the effects of climate change, including monster storms, wildfires, raging winter weather, plus the difficulty of getting the global community to come to a consensus on how to tackle the problem and there is one more reason to be nervous.
6. The prospect of hard-fought US midterm elections
Many fear the process could erupt into violence, such as the January 6, 2021 riots in the United States Capitol. Along with the increased uncertainty, the process and possible events surrounding it can diminish confidence in American institutions.
Invest with your eyes open
Stock prices are not necessarily diving toward higher interest rates. Inflation isn't always a bad thing, especially if it allows a company to raise prices and increase profitability, making their stock more attractive to investors.
But both developments add uncertainty to how investors think about where to put their money.
Yet global tensions, COVID-19 (with all its variants) and climate change are all adding more layers of uncertainty to the market environment.
While the fundamentals (job growth, earnings growth, revenue growth) offer solid investment opportunities as 2022 kicks in, one should not ignore the adjacent uncertainties.
