Market Outlook 2022: What to Expect?

The new year has come on the heels of two very strong years of market returns. The brief recession in early 2020 now looks like a faint memory. The markets come a long way since that time. What can we expect in 2022? This is an important question not just in the minds of investors, but also true of policymakers, central bank heads, and institutional money managers. Let us explore some of the key factors that can influence the markets in 2022.

Central banks and monetary policy:

The US Fed announced their tapering in late 2021. This would involve paring back on their bond-buying activity. The bond-buying was accelerated in the wake of the first wave of the Covid 19 pandemic in 2020 and was to a great extent influential in keeping the markets stable. With a sizeable portion of the populace vaccinated and the economy returning to normalcy, the Fed does not see the need for extraordinary quantitative easing anymore. The economy is expected to recover fully in 2022 and the Fed would like to position itself to address potential issues going forward. Addressing monetary policy through interest rates is a key agenda of the Fed. Short-term rates have hovered close to zero for the last two years and the Fed expects to raise rates to face a full-strength economy that might heat up. The reduction in bond buying is a first step in preparing for a rate hike. Another headwind is inflation, which is our next topic. Banks and financials are expected to do well in an increasing rate environment. See below a chart with the recent performance of a few ETFs that offer exposure to financials in the US.

Source: Morningstar

Inflation:

The topic that dominated the last two months of 2021 was inflation. It is likely to remain an important factor in 2022 as well. The US inflation rate has crept up to 6.5%, a level not seen in years. A significant contributor to inflation has been the supply chain crunch. The Covid pandemic has caused severe disruption to the flow of goods across the world. Many key raw materials including semi-conductors have been in short supply as shipping lines remain clogged, container shortage remains prevalent, and manufacturing rates remain tight. As demand returns in the developed world, the supply crunch is causing cost-push inflation. The tight labor market in the Us has also led to wage increases, another factor supporting higher inflation. The forecast for inflation for 2022 is around 3.5%, not an alarming number. However, the Fed and various other policymakers are ready to take measures if inflation creeps up higher than anticipated. From the perspective of returns, mild inflation is a positive factor for equity returns in general. In a higher inflationary environment, some segments of the market in fact find an advantage. These include businesses that have strong pricing power and sectors like energy, commodities, and REITs. See below the chart for a few ETFs in these areas.

Source: Morningstar

Earnings outlook:

Corporate earnings have been growing at a healthy pace ever since the recovery from the 2020 pandemic lows. Profit margins have been expanding. However, the pace of earnings growth is likely to slacken in 2022, based on consensus estimates. Nonetheless, the large technology players are expected to stay resilient to these trends. These include some of the popular names such as Apple, Tesla, Microsoft, and Google parent Alphabet. The semiconductor sector too is expected to continue having a rosy outlook in terms of both earnings and profit margins. Find below a snapshot of a few semi-conductor-based ETFs.

Source: Morningstar

IPOs:

Several large IPOs are anticipated in 2022. 2021 was already a bumper year in terms of large IPOs. We saw the likes of Robinhood, Coinbase, and NU Holdings make their debut in 2021. Some of the eagerly anticipated IPOs in 2022 include:

Chime, a fee-free mobile banking company based in San Francisco. Based on recent estimates Chime boasts a valuation between $34 and $45 Billion.

Discord is a popular online chat service. Discord offers voice calls, video calls, text messaging, media, and files in private chat servers. Discord is valued at over $15 billion.

Impossible Foods is a vegan-friendly company that makes plant-based alternates to meat. Impossible Foods is expected to IPO at a valuation close to $10 billion.

Instacart is a grocery delivery company. The firm uses a network of full-time shoppers to shop in real-time and deliver to its customers. Instacart is valued at close to $40 billion.

Reddit is the highly popular social news aggregation, discussion, and web rating platform. The firm recently was in the headlines for the meme stocks phenomenon. Reddit is expected to IPO at close to a $15 billion valuation.

Valuation:

The valuations of the US market with respect to both historical levels and compared to elsewhere in the developed world seems to be high. While it is difficult to say when valuations would revert to a mean, what is clear is the valuations in Europe and Japan are attractive. Europe's GDP is expected to grow over 4% in 2022, with the ECB continuing to do quantitative easing. Japan is expected to grow more than 2%. For those keeping an eye on relative valuations, these two areas offer opportunities for potential additional returns within the developed world. Find below a recent chart of a few ETFs exposed to this area.

Source: Morningstar

Conclusion and Investment options:

The markets ebb and flow on an ongoing basis. Economic growth, geo-political situations, corporate earnings, and extraordinary events like the Covid pandemic, all have influence over the markets making it a complex system to time correctly. What is known is, in normal circumstances, over the long run equity markets tend to outperform fixed income returns after adjusting for inflation. Staying invested, following a disciplined approach to investment, and allocating appropriately based on goals, income, and targets, are all key factors in generating wealth.

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