Stocks face rocker path in 2022 as Fed rate hikes

Investors had a lot to feel good over the holidays. Backed by a stronger-than-expected economic rally, the S&P 500 climbed 27% in 2021, the third biggest gainer of the past 20 years. US crude rose 55% to about $75 a barrel. Interest rates on corporate bonds hovered near all-time lows, reflecting a lower perceived risk of default after a year in which some businesses went bankrupt.

Economists polled by The Wall Street Journal expected the US economy to grow by 3.7% during the year, going forward in 2021. Instead, it is likely to expand by more than 5%. The unemployment rate fell far below economists’ estimates.

Still, some investors expect 2022 as well as 2021, with the Federal Reserve on the verge of raising interest rates, a new Covid-19 version in the country and dwindling government aid to families. Oil prices have already fallen 11% since their highest level in late October, reflecting traders’ concerns about slowing demand for the fuel. The S&P 500 traded sideways for much of the past two months, while some speculative investments, such as shares of smaller, fast-growing tech companies, fell sharply – hurt by fears that they would be particularly vulnerable to tighter monetary policies. will be sensitive.

A major concern of investors: How different problems might affect each other. The fresh wave of COVID-19 cases due to new or existing variants could slow economic growth by reducing consumer spending. But some also worry that such increases could help sustain already hot inflation by contributing to supply-chain problems and labor shortages – thereby pushing short-term interest rate hikes for the Fed. It becomes difficult to give, even when growth is slow.

The biggest threat to riskier assets like stocks is “inflation problems that prompt the Fed to tighten too much,” said Jim McDonald, chief investment strategist at Chicago-based asset-management and banking firm Northern Trust. “And one of the reasons for this could be supply disruptions related to the pandemic,” he said.

Such concerns are particularly evident in the bond market, where yields on longer-term US Treasury bonds have remained stuck in a narrow range below 2%, even as short-term yields have climbed — This shows that investors are both concerned about the economic outlook and believe that the Fed is going to raise rates almost three times in 2022.

Low long-term returns can in some ways be comforting to investors because they play a large role in determining the cost of borrowing in the economy. Lower yields also boost the stock prices of rapidly growing companies, especially by making their future earnings more valuable.

Economists, however, caution that higher short-term rates, even on their own, could slow the economy. And many think that long-term returns will increase as investors’ prices have increased more than this year.

Despite rising risks, many investors believe the coming year will power the market, delivering solid returns even if they are largely driven by government-stimulus programs. Don’t quite measure up to recent years.

Mr McDonald, for one, said corporate earnings are still likely to grow double digits in 2022. In line with this, his team favors safer assets such as cash and higher-rated at riskier assets such as developed-market stocks and lower-rated corporate bonds. Bond. He said long-term rates should be governed by technical factors, with the US Treasury continuing to overflow with savings.

Overall, analysts expect earnings to grow 9.2% in December 2022, according to FactSet, down from the 45.1% projected in 2021, but still higher than in 2017, when the S&P 500 was up 19%. .

At ease for investors, stocks have generally performed well in years when the Fed just started raising interest rates. Investors also indicate that each successive surge of Covid-19 has dealt a small blow to the economy as people learn how to deal with the virus. Many investors are also optimistic that inflation will ease this year, as the supply of commodities will match the demand. And some argue that the rise in Covid-19 cases is likely to accelerate inflation at a slower rate than it should be, meaning the Fed can only delay rate hikes if the economy ends a rough patch. does.

“If we get really very slow growth, I think we get very rapid deflation,” said Brian Nick, NuVin’s chief investment strategist. In that case, he said, it’s good that investors are already counting on multiple rate hikes for 2022 because it means the Fed could actually ease financial conditions by distributing less than that.

The prospect of rising interest rates, however, remains a concern for investors, with most expecting an increase in volatility—even if stocks tend to trend broadly higher.

High returns on government bonds can hurt stocks in many ways, from rising borrowing costs for businesses to giving investors options to earn good returns. The combination of strong growth and rising yields should generally help businesses in economically sensitive sectors such as banking and energy. But analysts warn that even this scenario could cause investors to exit tech stocks, which are heavily weighted in major indices.

Given how low interest rates have fueled riskier investments during the pandemic, some investors say, it’s hard to imagine avoiding a struggle with yields climbing on stocks.

If Treasury yields rise significantly, many investors believe such an increase will be especially hard on the most speculative trades: cryptocurrencies such as bitcoin; shares of small tech companies; And so-called meme stocks, including those from AMC Entertainment Holdings Inc. and GameStop Corp., have remained popular among individual investors despite their struggle to turn profits.

“There were a lot of signs of speculation, consumer and otherwise, in 2021, and I think we should expect to come down – it has already started to come down – in anticipation of the Fed taking away the punch bowl, ” What was said. Neuberger Berman’s portfolio manager Jason Tauber.

By some measures, stocks now trade at their highest prices relative to companies’ earnings since the dot-com bubble of the late 1990s. Still, some argue that they remain relatively cheap given the low bond yields, meaning there is room for yields to rise before the stock becomes largely unattractive.

A measure known as the excess CAPE yield—the inflation-adjusted bond yield minus the S&P 500’s inflation-adjusted earnings-to-price ratio—recently sat around 3%, up from a long-term average of about 2.5%. Upstairs, said Mr. Nick of Nuveen.

It’s still the case that “you’re getting a slightly better deal on stocks in general,” he said.

This story has been published without modification to the text from a wire agency feed