2022 U.S. Market Outlook: Compelling need for bottom-up approach to generate alpha in choppy markets
Published on January 12, 2022 by Venkatarao Bodapati
US equity markets had a stellar run in 2021, owing primarily to easy monetary policies by the US Federal Reserve Bank (Fed), which have helped stocks more than double from their March 2020 lows. The S&P 500 Index was up around 27% in 2021 and appears expensive relative to its history, based on price-to-earnings multiples. The index is currently trading at 21.2x one-year forward earnings, significantly higher than the 15-year historical average of 16.0x, as per Bloomberg data.
After a stellar run in 2021, the US equity market is expected to be in choppy waters as investors closely monitor the US Fed’s policy actions in light of persisting high inflation and developments around the Omicron variant of Covid-19. Heading into 2022, we expect earnings growth to remain strong on the back of pent-up demand and an economic recovery (3.9% economic growth in 2022, as per Bloomberg consensus data). However, given the current stretched valuation multiples, we believe there is no further room to expand current multiples, leaving equity markets to move mostly sideways in 2022.
Hardening inflation remains a focus for investors in 2022 as consumer prices remain higher for longer than anticipated by the Fed. Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated inflation levels. November’s inflation rate increased to 6.8% on a year-on-year basis — the highest in the past four decades. Consistently rising price pressure from food and energy products and global supply-chain bottlenecks (which are unlikely to get resolved anytime soon) are sending alarm bells at the Fed to raise interest rates to dampen inflationary pressure. In the December meeting (on 15 December), the Fed decided to accelerate the reduction in asset purchases to USD30bn from the earlier USD15bn mentioned in November, in light of the strengthening labour market (a relatively low unemployment rate of 4.2% in November 2021) and elevated inflation pressures. The Fed is now projecting the funds rate to increase to 0.9% at the end of 2022, suggesting two to three rate hikes, and to stand at 1.6% in 2023, pointing to three rates hikes. More importantly, it is unclear how aggressively the Fed will respond in 2022 and beyond to contain inflationary pressures while maintaining economic momentum, which could result in volatile or choppy markets in 2022 and likely in 2023 as well.
Furthermore, Covid-19 developments over the past two years has been the main market driver, due to easy monetary policies and a sustained rally, driven by the vaccination progress that has helped in the reopening of the economy. Now, worries over the Omicron variant and its impact on US equity markets remain unknown and too early to estimate. Many medical experts suggest the Omicron variant is more contagious than the Delta variant, but its symptoms are milder and expected to be less severe than the Delta variant; however, it is too early to come to a conclusion. Moreover, the spread of the Omicron variant is more aggressive in Europe, and many countries in Europe are planning to implement strict restrictions to flatten the curve, resulting in renewed volatility in the global markets, particularly in the US market, over the past three to four weeks. The CBOE Volatility Index (VIX) increased considerably in December. The VIX came in at 16.41 on 1 November and increased to 19.23 on 27 December (went up to 31.12 on 1 December 2021).
Despite the above headwinds, many analysts expect high single-digit returns (S&P 500 Index) with increased volatility in 2022, as many companies are expected to deploy excess cash in dividends and share buybacks and as the economy continues to recover in 2022. We believe these returns will mostly be stock-specific and not broad-based like in 2021. Hence, stock selection plays a key role in generating alpha for asset managers, which requires deep-dive fundamental analysis using a bottom-up approach. Asset managers need to deploy more resources to pick the right stocks for their portfolio to be competitive in the industry. At the same time, brokerage (sell-side investment) firms need to increase their breadth of coverage to advice clients to increase soft dollar shares in their wallet.
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About the Author
Venkat has over 17 years of experience in equity research and project management. He has been with Acuity since 2008, actively assisting sell-side equity research firms. In his current role, he has been providing equity research solutions to a regional investment bank in the US for the past nine years. Prior to joining Acuity, Venkat was a scientist at the Indian Space Research Organization. He holds a master’s in Business Administration from MDI, Gurgaon (India), and a bachelor’s in Mechanical Engineering from NIT, Warangal (India).
Originally published at https://www.acuitykp.com.