This year has been profitable in the stock market from an investment perspective. The S&P 500, the Dow Jones Industrial Average, and the Nasdaq, all the three indexes, have had a record-setting in 2021. In reality, there are still many uncertainties as the economy returns to its full capacity.
There are three major hurdles to push from, the first being Omicron’s ever-growing threat as it hampers the economy. Second is the high inflation rate that has been persistent, and last but not least, the interest rates, which are yet to be determined by the Federal Reserve. How will the combination of the above three factors affect the stock market’s future? This is the real question one may ask.
As we head into 2022, what would be the environment of the stock market? And how can the investors position themselves on the returns from the stock market? Here are a few things an investor should keep in mind as we venture into the new year.
While sharing with Congress, the Federal Reserve’s Chairman, Jerome Powel, said that he suspects that the inflation may stick around longer than what was anticipated at the end of November. Using data as of December 3, 2021, according to the CME FedWatch tool, due to market pricing, there are 80% chances that the Federal Reserves will start to increase the interest rate by the middle of 2022. There are 87% chances there may be more once the rate hike by the end of the year. The pressure is put on the Federal Reserve to inflate the interest rate due to the inflation. But this decision will be based on how strongly the economy recovers in 2022.
Director of wealth management research at D.A. Davidson in Seattle, James Ragan, said that the rise in the interest rate would initiate the change in the market, but it won’t hurt the appetite for stock investment. However, it could degrade the performance of certain stocks like those related to growth stocks favoring value-oriented names.
CIO at Mercer Advisors, Don Calcagni, said that higher interest rates would reduce the profitability of the growth-oriented equities; he assured that not all stocks react to the inflated interest rate as growth-oriented stocks perform. Companies having low earnings compared to a much higher valuation can undergo stress than those like financial and energy who are lower-priced, discounted value stocks.
It is essential to know that COVID-19 can change the rate at which the Federal Reserve may increase the interest rate in 2022. However, according to Don Calcagni, the interest rate will slowly increase, giving the market time to make necessary adjustments.
The experts are optimistic about the equities even though volatility in the market will be experienced as the Federal Reserve increases the rate of interest. After the disruption in 2020, in 2021, the U.S. economy focused on economic recovery, recording a robust for a pretty good time. Compared to the first quarter, which saw a growth in GDP of 6.4%, the second quarter rapidly grew to 6.7% annually. However, the third quarter was measly 2.1% after the first half. This drop was fueled due to low consumer spending and a bottleneck in the supply chain.
The economic picture was turbulent in 2021 due to an inflation surge. Disruption in the supply chain, the emergence of labor deficit, and continuous demand for goods and services, proved to be few catalysts whose combination exerted pressure on prices, thus inflating inflation.
Even though the economic recovery is taking place faster, the investors could expect continuous growth in the U.S., but not at the same rate of growth as it did in 2021. Therefore, the investors need to be aware of the challenges which will help them navigate the market as these challenges will not subside within a short period. Don Calcagni warned the investors of the triple threat in 2022 in the form of growth, inflation, and interest rates.
The growth of U.S. companies may not be as same as in 2021. Therefore, the investors consider investing in the global economy as the economic growth rate will be greater abroad. Don Calcagni further stated that there would be tremendous economic growth potential in European, Southeast Asian, and South Asian markets compared to the U.S. market.
The experts suggest the investors invest in durable businesses which have been maintaining strong earnings and cash flows as these companies are well equipped to particular risk factors 2022 has in store. Don Calcagni suggested including companies in their portfolio that have high profitability, with their margins expanded, and can increase their supply chains catering to the consumer’s demand.
The Financial, energy, and health care sectors are the ones that should be shortlisted. In addition, companies that also share the basic characteristics as the ones mentioned above can also be shortlisted. Amongst these, the companies with reasonable valuations should be considered. There are many ways to check the valuation of a company, but the most basic one is to check its relatively low price-earnings ratio. As we enter 2022, and the challenges that this year has to offer, the strategy of diversification of portfolio which every investor should go for to hedge the losses.
Investors might want to consider diversifying beyond the S&P 500 as the market size and the market share of some of the largest U.S. companies have grown during the economic recovery. Don Calcagni said that the portfolio should include companies with smaller to midsize capitalization. He continued that while large-cap companies are stable, profit can be booked by having small-cap companies due to excellent returns due to their inherent risk.
According to the experts, U.S. stocks have performed magnificently throughout the year, with up to 20% in the S&P 500 outpacing non-U.S. based stocks for the past decade. In order to diversify the portfolio, it’s time to add international stocks to the existing portfolio expert advice.
The addition of non-U.S. stocks to the portfolio is excellent as they can be bought at a discounted price since the valuations are pretty high in the U.S. market. Non-U.S. stocks have an attractive value with greater economic growth potential. However, these non-U.S. stocks have a discounted value of roughly 20% to 30% as against their U.S. counterparts, says Don Calcagni.