Market Views: Are US equities headed for a big correction in 2022?
The US equity market is trading resiliently this week, despite headwinds from the Omicron variant, inflation, and more rate hikes — although it’s uncertain how long this can last.
The Federal Reserve held its most hawkish meeting in recent years last week, signalling three interest rate hikes in 2022 in response to decades-high inflation. This projection is up from the September meeting, when half of the Fed members saw at least one rate hike in 2022.
The central bank also raised its GDP growth forecast for 2022 to 4%, up from 3.8%. Meanwhile, core personal consumption expenditures (PCE) inflation estimates were also raised to 4.4% for 2021 and 2.7% for 2022 — up from September’s projections of 3.7% and 2.3% respectively.
After the Fed signalled accelerated rate hikes in its December 15 meeting, the S&P 500 lost 0.9%, the Nasdaq Composite slumped 2.5%, and the Dow Jones Industrial Average slipped 0.08% on the next trading day. Retreating further during Monday trading amid the worsening Omicron outbreak, the three indices have since shown resilience and climbed back to their pre-Fed meeting levels.
In 2021, the three indices have rallied at a 15%-25% level year to date and kept hitting record highs. But it was also trading at high valuations.
This week, AsianInvestor asked asset managers where they think the US equity market is headed in 2022; whether it is close to a correction; and what their strategies are.
The responses have been edited for brevity and clarity.
Ralph Bassett, head of North American equities
abrdn
With ongoing uncertainty around supply chains, inflation, tapering and Covid, we expect markets to be headline-driven as we see the reframing of what growth and margins will look like for 2022.
Material corrections are hard to predict and often unexpected. We believe markets will be supported by “decent” economic growth and while interest rates move higher with inflation, public companies will generally benefit – particularly commodity companies or those that can price to absorb inflation.
Key risks include rising Covid infections; inflation and supply-chain pressures, which will challenge especially smaller companies more exposed to input and commodity costs. If interest rates rise with strong economic growth, this should be positive for equities. But if the Fed tightens to restrict inflation and negatively impacts economic growth, slower growth or recession may follow.
We see banks as undervalued, relative to the market, and we have retained our overweights to industrials and materials companies, given the improved outlook. Our focus is also on value-added companies that can price for inflation but are not commodity-oriented, as longer-term conviction and competitive barriers are unpredictable.
Kerry Craig, global market strategist
JP Morgan Asset Management
We expect positive returns from US equities in the year ahead, albeit of a lower magnitude than seen in 2021. The outlook for earnings remains robust and valuations have been supported by negative real yields. Valuations on US companies may come under pressure as policy normalisation begins and yields start to rise. A large jump in yields driven by a repricing of the rates outlook or inflation expectations could set off a correction in US equities given the higher weight in growth stocks. This is not our base case, and we expect the strength in earnings will outweigh growth or valuation concerns.
Margins are another crucial aspect of the outlook. The profit margin for S&P 500 is near its record high and there may be an expectation that margins will become compressed, reducing earnings growth. However, companies appear willing to pass on the higher input costs to end consumers and are seeking to increase productivity, both of which could keep margins elevated compared to history.
A US economy in its mid-cycle phase suggests a more balanced approach to style. Value-orientated companies historically do well as yields rise and the yield curve steepens. Meanwhile, secular themes driving growth sectors may come back into favour as valuations fall. The US economy is on a strong footing heading into 2022. There is scope for some front loading of fiscal stimulus if the Build Back Better plan is delivered, and this could add to the returns of small-cap stocks which are more geared to the domestic economy.
Mark Baribeau, portfolio manager
PGIM Jennison Global Equity Opportunities Fund
The Fed’s stance led investors to moderate expectations for economic growth; however, over the longer term, companies with high returns on equity, strong free cash flows, and asset-light business models will likely fare better than companies forced to incur higher costs that dampen profitability. Growth stocks don’t need a roaring economy to grow, making them more attractive as GDP and corporate earnings growth revert to pre-Covid trends.
We continue to find the best growth opportunities in the same secular themes we’ve seen drive market leadership and profit growth over the past two years. While there may be short-term headwinds from challenging year-over-year financial comparisons and cyclical pressures, we believe accelerated trends in consumer and enterprise behavior have staying power and will continue to deliver growth.
We are currently witnessing a genuine transformation of the economy through technology, providing rapid growth for innovative companies throughout the value chain – from semiconductors to cloud data managers to software solutions enabling everything from digital payments to ubiquitous communication with customers. We are focused on evaluating the companies operating in these areas to identify the players with the business models and management teams most likely to capitalize on the opportunity and build significant scale over time.
Alexandre Tavazzi, Asia CIO, global strategist
Pictet Wealth Management
Renewed Covid concerns have emerged while sectors with lofty valuations are exposed to inflation and higher interest rates. We think the complex and volatile environment we are in will likely accentuate polarisation between the weakest and strongest companies. Omicron is the wild card for 2022, but a larger part of the population is now vaccinated, and governments and central banks have learned how to address the consequences of lockdowns.
A correction is rather unlikely, even when factoring in corrections in valuations, dividends and buybacks. The S&P 500 earnings are expected to grow by 10% in 2022. More than a correction per se, we expect a rebalancing of markets and portfolios in 2022. Despite the central banks tightening measures, monetary support will remain strong, supporting equity markets valuations.
Growing employment and the build-up of savings during the pandemic will ensure that consumers in the US and elsewhere continue to spend. But that spending will move proportionately more towards services, helping undervalued stocks in sectors such as travel and hospitality. Moreover, we think the coming years will be characterized by a surge in capital investment and infrastructure spending to reach governments' net zero CO2 emissions ambitions. Quality industrial companies should benefit from this structural trend.
Kevin Anderson, head of investments, Asia Pacific
State Street Global Advisors
We enter 2022 with a small overweight to US equities biased towards smaller cap stocks. We think that risk pricing in equities markets measured, for example the Cboe Volatility Index (VIX), will remain elevated in 2022 as a result of multiple factors which could shock a fragile equity market, namely the risk of monetary policy missteps in addressing inflationary pressures, the public health response to the Omicron variant and US-China strategic rivalry.
Growth sectors were clear winners through the pandemic thus far buoyed by a massive injection of monetary and policy stimulus. However, peak policy accommodation is behind us, and as inflationary pressures rise and monetary policy tightens, we think that the baton will pass to quality.
Neither growth nor value would likely be clear winners in 2022. Higher rates are likely to create headwinds for certain growth sectors, but a flattening yield curve is going to be less supportive of value. We favour cyclical sectors including industrial, materials, energy and financials with strong fundamentals.
Chang Hwan Sung, portfolio manager, investment solutions
Invesco
Recently market participants have been revising down future growth expectations as the economy transitions its growth engine from fiscal stimulus to private sector demand. The latest developments on the Covid front are likely to increase the uncertainty of growth estimates over the next year.
Within US equities, we are less positive on cyclical factors such as value and small size but prefer defensive factors like quality and low volatility, which tend to outperform via a combination of declining growth expectations and higher-duration properties. We are less bullish on the momentum factor, which has historically underperformed at cyclical turning points when fundamental and price dynamics shift. Similarly, we think it makes sense to reposition toward defensive sectors with quality characteristics and positive exposure to lower bond yields such as information technology, communication services, health care, consumer staples, etc.
From a regional perspective, we prefer developed markets over emerging markets as decelerating global growth and risk sentiment don’t bode well for investors’ appetite toward riskier markets.
Sébastien Page, head of global multi asset
T. Rowe Price
Equity valuations are elevated, but earnings strength buoyed equities in 2021 - although it will be difficult to grow earnings at the same pace in 2022, due to moderating economic growth, tightening central banks, and Covid-19 uncertainty. The US stock market did not appear to be in bubble territory, but the US valuation premium appears extended. Technology companies could be particularly vulnerable to rising rates.
Global trade appears likely to improve as supply chain concerns ease and vaccination levels rise, but coronavirus uncertainty may delay progress. Valuation fundamentals and cyclical factors could favor the “recovery trade” in 2022. Financial stocks, which carry a heavy weight in the value universe, historically have tended to outperform in a rising interest rate environment. And small-cap stocks typically have done well during economic recoveries.