No single change damages our pursuit of happiness, but collectively they take a toll. When will COVID-19 end? When will it all be OK?
The answer is, hopefully, sooner than we might think. I believe that this is the year COVID-19 finally moves into the endemic phase. Consumer sentiment should start to improve once Americans feel a true inflection point. We don’t know when that will start, but thanks to science and experience, we are much closer to that phase today than two years ago.
This brings us to 2022, a year in which the U.S. should enjoy more tailwinds than headwinds, making a positive impact on both markets and the economy. Here are the major themes to watch for:
1. Pandemic to Endemic — COVID-19 should shift from pandemic to endemic. Less virulent strains in combination with mass vaccination, natural immunity, and multiple treatment options should make extraordinary and growth-prohibitive governmental and central banking measures less likely.
2. Less Government Stimulus, But Stimulus Nonetheless — With the pandemic fading, years of massive stimulus — more than $5.8 trillion in the U.S. alone — will, too. We should see far less in 2022, even if a modified version of the Build Back Better plan passes in Washington. Stimulus as a percent of GDP was 10% in 2020 and 11% in 2021. It should fall to the 2% to 3% range in 2022.
3. Moderating GDP Growth — Overall economic growth should moderate from the 2% to 6% quarterly growth range we saw in 2021 to a more modest but still strong 2% to 3.5% range. Looking at the critically important U.S. Leading Economic Index (LEI), we can glean that a recession over the next year is highly unlikely. LEI levels are hovering around +10. When they are this elevated, falling to the zero bound or below — spelling a recession — is typically years away.
4. Strong Corporate Earnings — While it won’t keep pace with 2021′s recovery, we should still see earnings growth in the 9% range for the S&P 500. To put this in perspective, the S&P 500 companies during 2019 earned in aggregate $163 per share; 2022 should bring earnings to $223 per share according to FactSet.
5. Tamer Inflation — Inflation almost has to self-correct and moderate. Think of it this way, if it didn’t, economy vehicles would reach the $50,000 range. That being said, I think it will remain more elevated than it has been over the past decade. What this means is that the average investor will want to look at owning companies with pricing power.
6. A Hiking Fed — The Fed has kept interest rates exceedingly low over the past two years in response to the circumstances caused by the pandemic. As COVID-19 moves into an endemic phase and the U.S. economy continues to gain momentum, the Fed will likely raise rates to combat inflation and return to a more normal interest rate environment. This would raise borrowing costs in the U.S., but higher rates should benefit massive parts of the economy. Think banks, financial institutions, and higher rates of interest for millions of American savers.
7. Politics Back in Focus — Historically, election years cause a heightened level of market uncertainty, which might keep first- and second-quarter gains in check. However, midterm election years historically tend to be strong for markets in the order of 9.9% on average. And once the elections are settled, the following twelve months are typically better, averaging returns of 15%. Going back to 1946, there have been no negative S&P 500 returns in a 12-month period following a midterm election.
The bottom line is that good news in 2022 should far exceed the bad. The election cycle suggests a muted stock market for the first few quarters but lower inflation, and strong earnings growth. The pandemic moving to the rearview mirror should bode well in the year ahead. Coupling all of this with interest rate normalization could bring rewards for dividend-seeking investors. I’m also realistic in that I cannot predict the future, and as an investor I’m focused on participation instead of perfection.
Be mindful of the challenges, but I’m hopeful for what I think will be a prosperous 2022.
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