Volatility on the horizon
Three things to watch in 2022.
The S&P 500 has rallied by 25% in 2021—marked by 67 record closes and a 53% year-over-year increase in corporate profits. But in 2022, we expect a muted gain of only about 10% for S&P earnings to $230 and stock prices to 5,300, with higher volatility. We see three developments that could drive that.
Fed course correction as inflation rages Core PCE hit a 31-year annualized high of 4.1% in October. In November, core PPI leapt a record high 6.9% and core CPI rose to a 30-year high of 4.9%. The Federal Reserve responded yesterday by doubling its monthly tapering schedule to a pace that would complete it in March 2022. We expect three quarter-point rate hikes to follow in 2022, the first of which could be in May, and four more in 2023. How stocks will respond depends partly on how President Biden fills the three open seats on the Fed’s board. Will the new, presumably more dovish Fed follow through on these policy changes?
Uncertainty of Covid’s omicron variant While the delta variant remains the overwhelming source of new Covid cases in the U.S., omicron is on track to cause more than one million infections in the U.K. by the end of December. Observing the trajectory and economic impact of omicron there over the next several months may prove insightful. Pfizer and Moderna are confident they can produce a reformulated vaccine booster to combat omicron by next March.
Build Back Better (BBB) on life support The Congressional Budget Office has said that when stripped of sunsetting gimmicks, Biden’s supposedly $1.75 trillion reconciliation bill really prices out at $5 trillion, paid for with much higher federal debt and taxes. Given the surge in inflation, that much additional spending is like pouring kerosene on a bonfire. Moderate Democratic senators, such as Joe Manchin (W. Va.) and Kristen Sinema (Ariz.), are demanding that the bill be shrunk and better targeted to support those with the greatest needs. As other moderate congressional Democrats look ahead to the midterm elections and consider their own career survival, we could see BBB scaled down considerably, if it passes at all. We believe that equities would respond favorably to either, leading to a rise in stocks then and another year-end rally after the elections.