The stock market has been volatile this past week, today included. There have been many factors that have abetted the volatility: increasing Covid cases due to Omicron, the Fed statement on Tuesday wherein the stock market liked that the Fed would raise interest rates in 2022, followed by consternation that the Fed would raise rates, and finally by “quadruple witching” options contracts that expire today (Friday). Moreover, 2021 has been a good year in the stock market and investors likely are taking some profits to lock in gains for the year. I believe all of these issues and others set up 2022 to get off to a good start and to be a good year for the stock market. And by that I mean the major indexes, not specific stocks.
There are several broad reasons why I remain bullish for 2022:
- Interest Rates: I have written before that higher interest rates affect high-multiple tech companies not necessarily because higher rates mean higher borrowing costs; most tech companies aren’t leveraged to the hilt so borrowing costs aren’t a huge factor for them. Rather, higher rates cause pain with tech company stocks because higher rates mean higher discount rates used for net present value calculations on future corporate earnings, and higher discount rates translate to lower theoretical values for the tech companies. All that said, I believe discount rates have room to expand from where they are now and still justify current valuations. As my favorite economist Brian Wesbury of First Trust Advisors says in a recent blog, current valuations can still pencil at a 10 Year Treasury Rate of up to 2.5%. That rate is currently about 1.5%. If the Fed does 3 rate rises in 2022, that would mean a rise in short term rates of 75 or maybe 100 basis points for the year, phased over time. And that doesn’t mean the 10 Year yield will rise in lockstep with the Fed’s actions. Wesbury projects the 10 Year to end 2022 at a yield of about 2.0%, and we can all work with that. By the way, if so, that would be good news for the mortgage and hence the housing markets as well.
- Continued Government Stimulus: 2022 will still see plenty of monetary and fiscal stimulus, if perhaps at a lesser rate than during 2021. The Fed said they would taper its bond purchasing, not stop it in its tracks, and so there will be that for at least Q1 2022. As for fiscal stimuli, the Infrastructure bill has passed and some of that will be doled out in 2022. Though Build Back Better doesn’t look too good, I believe some spending bill will pass; even “stick in the mud” Senator Manchin has said he is ok with $1.5 Trillion of new spending. That’s not chump change. Look for a new effort to pass a spending bill early next year. I’m not arguing here that it should happen, merely that if it does happen it will be stimulative to the economy and corporate earnings, the future ramifications be damned.
- Inflation: I have also written before that the Fed wants to inflate its way out of the turbulence it faces. Inflation is good for corporate revenues and it could be good for corporate earnings if corporations keep there costs in control, which is of course easier said than done. Owning hard assets – housing, gold, land, but not automobiles – has historically been good during inflationary times, and so can be stocks. Take high margin tech stocks: while they may be affected by things such as higher chip prices and certainly by higher labor costs, they are not as affected by higher raw materials costs as are traditional manufacturing companies. Moreover, the revenue side for tech companies is likely more price elastic than are revenues for manufacturers. For instance, I would bet that Google or Facebook would have an easier time raising the rates they charge to advertisers than a supermarket has in raising its prices. I believe the tech economy will fare better during an inflationary period than we have seen with companies in past inflationary periods. That said, it has been a while since we have had real inflation, so let’s see how it plays out.
- COVID: While we are seeing an increase in case numbers and some states are back to having mask mandates (kind of), we are far better off than we were 12 months ago when we were at the beginning of a Winter surge that ended up getting a lot of people sick and resulted in shutdowns much more significant that the current mask mandates. With vaccination rates as high as they are, and with all signs in the direction that Omicron is relatively more mild that previous variants, look for this Winter to be not nearly as problematic for Covid as was last Winter. We’re not done with Covid yet but it certainly looks better than it did.
- TINA: TINA remains a factor: There is no alternative. Interest rates, though a bit higher (possibly) in 2022, still offer little in the way of return. Going farther out on the risk spectrum will still look appealing by comparison.
- Technical Factors: If investors are selling now to realize 2021 profits and to perhaps stay in cash while the Omicron variant plays out, perhaps 2021 may end the year oversold and 2022 may see renewed buying. Just a hunch on my part.
I remain in the camp of recommending that investors overweight stocks during 2022. I’m not a doom-and-gloomer by nature and so tend to have a bullish bias, but I believe the factors I outline above tip the scales in favor of continued upward pressure on stock prices.