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Market Outlook Second Half of 2022
U.S. equities are likely to whipsaw throughout 2022 and will most likely have trouble recovering back to their levels set in January 2022. Multiple headwinds -- Fed tightening, slowing GDP growth, more difficult profit comparisons and rising inflation – will create an uphill battle for the markets for the remainder of the year. Years of transition from economic recovery to expansion are characteristically uneasy for stocks, and this one may be particularly challenging given the unique aspects of geopolitical turmoil, extreme inflation and the delayed policy unwind of pandemic support. The S&P 500 and Russell 2000 fair-value models imply the indexes are likely to be far below all-time highs in the year ahead. Each index must contend with tricky inflation conditions and come to terms with diminished policy support. The leading sectors that can prosper during a period of inflation/higher interest rates - energy, materials, small caps and financials - are expected to out-perform.
The leading sectors that can prosper during a period of inflation/higher interest rates - energy, materials, small caps and financials - are expected to out-perform.
As the Fed normalizes policy with multiple rate hikes anticipated throughout the year, earnings growth is likely to provide some support for stocks in the year ahead, but a bear case is emerging where the central bank is forced to choke off growth to root out dug-in inflationary conditions. Multiple scenarios are on the table. One unlikely scenario is that a bigger than expected surge in the economic growth creates S&P 500 Index profit growth of 21%, mainly due to stronger-than-expected new-orders gains and rising commodity prices. Another scenario is a bear case, that is the U.S. hits a typical recession in 2H2023, causing profit growth to fall 13%. Another negative scenario is a stagflation case, that would be potentially less severe on earnings growth, as commodity-driven sectors stay afloat, yet total profits fall due to higher labor and input costs.
Earnings trends are pointing to tougher comparisons going into the 2H2022, with S&P 500 Index profits expected to rise just +4.6% in 2Q22, +9.96% in the 3Q22 and +10.54% in the 4Q22. Every sector in the S&P 500 is expected to face an earnings per share (EPS) slowdown, though real estate and other defensive sectors should see the smallest reductions as 2023 approaches. Industrials and materials may be impacted the most by an economic slowdown. While energy has the strongest upside revision breadth powered by soaring oil prices, followed by tech and materials. Due to their strong cashflow and ample dividend yields, traditional defensive sectors, such as utilities, communications and staples, would be minimally impacted from slower economic and profit growth. In summary, it appears to be an upward climb for stocks the remainder of the year with the Fed tightening cycle just beginning, rising inflation and slower economic growth.
Written by Daniel Morgan, Senior Portfolio Manager
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