Markets 2022 – Flat is the new up

By David Nelson, CFA CMT

As 2021 draws to a close it’s easy to identify the catalysts and factors that drove equity performance. It gets a little harder for strategists charting a course forward especially with data shifting dramatically month to month and a news cycle that presents us with a new set of challenges almost daily.

S&P 500 vs Next 12 Month EPS vs Forward PE

Data by FactSet

2021 for markets was an earnings driven rally. The only thing that went up faster than stocks were analyst estimates as Americans crawled out of the bunker into the sunlight, a process that is still underway. Even with the market up another 26% this year, forward valuation measures like a simple PE ratio Price/Earnings are lower than the start of the year. The danger for analysts and investors is to extrapolate forward always expecting current trends to continue. The trend is your friend right up to the time it isn’t. As we head into the end of the year it’s a good time to start thinking about 2022.

At the start of the year the 12 month forward estimate for the S&P 500 was $165 vs $217 where it sits today or 31% growth. During that time, the forward PE dropped a full turn from 22.7x to today’s 21.6x. All fuel for a raging bull market.

S&P 500 Earnings Growth 2022

Data by FactSet

A repeat performance would have to be driven by similar metrics but isn’t supported by current data. No, it’s not a call for a bear market and my view could change as the data does but with 2022 earnings growth expected to slow to just 8%, it’s prudent to suggest that price momentum is likely to slow dramatically. Flat could be the new up for 2022 equity investors. 

Exploiting the themes underneath the surface will be both the opportunity and challenge for investors to make money.

Challenges to overcome

My post last week on Demand Destruction and the potential for an already damaging inflation cycle to continue still tops the list of macro concerns. The 6.2% headline CPI last week shocked the street breaking a 5-week winning streak for the S&P 500.

Data by FactSet

Combing through some of the broad macro research points to other concerns beginning to weigh on Wall Street sentiment. Goldman’s Jan Hatzius points out that while the unemployment rate continues to fall quickly, labor force participation has made no progress since August 2020.

Data by FactSet

With supply chain issues still a challenge on an international scale, a September JOLTS number coming in at 10.7 million indicates we still have a long way to go before this issue is resolved. You can’t get raw materials and finished product through the pipeline if employers can’t fill mission critical positions.

What should investors do now?

Too many investors try to adjust their asset allocation or risk bucket around current data and or the latest news cycle. Late-stage bull markets often force conservative and moderate investors to move up the risk spectrum and some growth investors giddy with recent success to turn to options and leverage to push the envelope even further.

It’s a similar thesis in bear markets. The call to reduce equity exposure as markets go down is equally compelling sometimes forcing a wholesale equity purge which all too often proves to be the bottom of the cycle.

S&P 500 2 Years

Data by FactSet

If you’re a moderate investor based on both your future needs and tolerance for risk that’s where you should be even after the market has run up 114% off the bottom.

We’re in a seasonally strong part of the year with just 32 trading days left in 2021. If you find that you’re over extended and have drifted out of your comfort zone now is a good time to at least have the conversation. Remember your life isn’t an index. Resist the urge to play catch up.