David Joy, Chief Market Strategist, and Russell Price, Chief Economist – Ameriprise Financial
For stock-market investors, 2021 was a rewarding year. The S&P 500® index rose by more than 20% in price-only terms, more than twice the average annual price return of the past 40 years.
A uniquely favorable set of conditions led to these gains. Massive fiscal and monetary stimulus, strong earnings, and progress against the pandemic (albeit uneven) have combined to create strong demand and rising economic optimism. From its pandemic low in March 2020, the S&P 500 has more than doubled.
Moderating expectations for earnings, stock prices
As is typically the case, however, the best returns from the early days of the economic cycle are likely behind us. That is not to say that the current bull market is about to end. Rather, it means that stocks prices likely already reflect much of the good news from both the policy support and medical response to the pandemic, leading to more modest gains ahead.
To be sure, corporate earnings are still growing, but are expected to slow over time. Whereas earnings likely grew by roughly 45% in 2021, they are expected to slow to roughly 8% - 10% growth in 2022, a pace more in line with their long-term historical average.
And while monetary policy remains exceedingly accommodative, it is in the early stages of a slow adjustment to more closely align with the current health of the economy. The Federal Reserve has already begun to slow the pace of its bond-buying program, reducing the pace of liquidity injections. And the Fed funds rate could be poised to rise in 2022.
Relatively high valuations are another factor that may slow the future pace of stock-price gains. Compared to earnings, the price of stocks is expensive in historical terms. Such lofty valuations can be justified by the combination of low interest rates and strong earnings growth. But as those two supports begin to moderate, the hurdle for stock prices to move higher becomes somewhat more challenging. For those reasons, now may be an opportune time to consider meeting with your financial advisor to consider a portfolio rebalancing.
Perhaps the good news for stock investors is that expected returns from bonds offer little competition. At present, 10-year Treasury notes are yielding 1.45%, little to get excited about, especially with inflation currently running well in excess of that.
Corporate bonds offer some additional yield, but it is quite low compared to history. Importantly, however, bonds do provide a measure of portfolio diversification, which may be quite welcome should stocks prices correct at some point.
The path for the U.S. economy
We believe the U.S. economy should also do fairly well in 2022 and forecast it to grow by 4.5%, before inflation. Consumers and businesses are in good positions to spend and invest, in our view, but inflation will likely remain a key concern, especially at the start of the year.
Currently, we forecast the Consumer Price Index (CPI) to start the year with prices about 7% higher than year-ago levels, primarily based on higher prices for goods. As the first quarter of 2022 comes to a close, however, we believe inflation could begin to subside. At about that time, the CPI will be coming up against higher year-ago comparisons, and price trends for some goods could moderate as availability improves.
We believe Fed officials will take notice of any slowing of inflation pressures. They could take a cautious approach in hiking interest rates to a more normalized level versus zero, the current lower level of their target. According to Bloomberg, a consensus of forecasters looks for the Fed to hike its main overnight interest rate two or three times in 2022. Yet the Fed funds rate could still end the year at a very modest 0.55%.
If you have questions about current conditions and want to discuss your investment portfolio, consider a review with your Ameriprise financial advisor.