Batting .500 Batting .500\images\insights\article\baseball-player-hitting-ball-small.jpg January 12 2022 January 12 2022

Batting .500

Two early-year stock market indicators point in different directions.

Published January 12 2022
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The good news for investors is that the S&P 500 enjoyed a terrific year in 2021, rising 26.9% (28.7% on a total return basis), fueled by a 50% increase in corporate profits. Moreover, since its pandemic trough in March 2020, the S&P has surged by 113% (119% total return), driven by a sharp recovery in P/E multiples, as the economy rebounded from its deepest but shortest recession in history, thanks to extraordinary fiscal and monetary policy intervention.

But the bad news, as we turn the page to calendar 2022, is that we’re expecting no better than a 10% increase in stock prices to our year-end target of 5,300, which is roughly in line with our expected increase in S&P corporate profits to $230. We believe that generous fiscal stimulus is in the rearview mirror, and with inflation at 40-year highs, we expect the Fed to aggressively withdraw its policy accommodation. It could complete its bond-buying taper in the first quarter, and we anticipate four quarter-point rate hikes this year starting in March (with four more in 2023) and at least passive (if not active) balance-sheet shrinkage later this year.

Consequently, we’re expecting a choppy year with significantly greater financial-market volatility compared with 2021. Benchmark 10-year Treasury yields have surged from 1.35% to 1.75% over the past five weeks, while the S&P plunged 5% over the last week. We expect Treasury yields to rise to 2.50% this year. Stocks are at risk to pull back 8-12% intermittently during the first three quarters of 2022, before rallying hard into our year-end target, due to what we believe will be favorable midterm election results in November.

Two early-year stock market indicators we monitor have produced mixed results. The Santa Claus rally yielded an above-average gain of 1.4%, which points to a potentially low double-digit gain this year. But the early January Barometer fell 1.9%. It’s a coin flip for stocks to right themselves by year-end.

‘If Santa Claus should fail to call, bears may come to Broad & Wall’ The Stock Trader’s Almanac defines the Santa Claus rally as the last five trading days in December and the first two trading days in January. Over the past 53 years since 1968, the S&P has been positive over this seven-day period 41 times (77% positive hit rate) by an average of 1.3%. This year’s results were slightly better, with a nominal gain of 1.43%.

The Stock Trader’s Almanac reports that 66% of the time (35 out of 53 observations), the direction of the full year—positive or negative—is the same as that of these seven trading days. But when these seven trading days are positive, as they are this year, the stock market finishes the year in positive territory 76% of the time (31 out of 41 instances).

In the 31 years in which the Santa Claus rally rose at least 1% during these seven trading days, the S&P increased an average of 2.8% and a median of 2%. That yielded an average positive return of 9% and a median return of 13.4% for the full year, consistent with our fundamental forecast for a 10% gain for the S&P this year.

Mixed results for ‘Early January Barometer’ Historically, as the first five trading days of January go, so goes the full year. Since 1950, Jeffrey and Yale Hirsch at the Stock Trader’s Almanac report that 69% of the time (50 out of 72 observations), the direction of the full year—up or down—is the same as that of the first five trading days of January. But when the first five trading days of the new year are collectively negative, as they were this year, the stock market still manages to finish the year in positive territory 56% of the time (14 out of 25 instances).

Negative start to 2022 Over the first five trading days of 2022, the S&P declined 1.87%. Over the past 72 years, according to the Stock Trader’s Almanac, in each year’s first week, the S&P has posted a median gain of 0.70% and an average gain of 0.32% (within a wide range of positive 6.2% to negative 6%).

We attribute this year’s bottom-quintile performance to two fundamental bombshells last week. On Wednesday, the Fed released the minutes from its policy meeting in mid-December, revealing plans to taper its bond buying more quickly and hike rates more aggressively than previously projected. The minutes also revealed policymakers discussed actively shrinking its $9 trillion balance sheet. Last Friday, the Labor Department released the December nonfarm payroll report. It showed that average hourly earnings had soared 0.6% month-over-month, which annualizes to a massive 7.2% growth rate. Stocks fell 1.9% and 0.4% on Wednesday and Friday, respectively.

Wonky midterm election years There have been 18 midterm elections over the past 72 years, and the S&P averaged a miniscule 0.1% in the first trading week of each, with a median gain of 0.5%. For the full year, stocks averaged a 6% gain, with a median gain of 11.4%. But over the past 70 years, most of the stock market’s gains in midterm election years have come in the fourth quarter—after drawdowns over the first nine months—a trend we believe will repeat in 2022.

We are sticking with our 5% overweight in stocks and 5% underweight in bonds, with a 90% duration target. To help preserve capital during a correction, we are focused on economically sensitive, lower-risk, less expensive, lower-beta stocks with better dividend yield support. These companies are enjoying strong earnings growth, because their pricing power allows them to recoup higher labor, commodity and transportation costs. So, we remain overweight domestic large-cap value, domestic small cap and international stocks.

More to come We’ll return with January Barometer, Part II, in February, after the S&P has generated investment returns for the entire month of January, to see what potential full-year market implications we can draw and to identify what the top-performing industry sectors may be for the full year.

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Diversification and asset allocation do not assure a profit nor protect against loss.

Price-earnings multiples (P/E) reflect the ratio of stock prices to per-share common earnings. The lower the number, the lower the price of stocks relative to earnings.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Federated Advisory Services Company