You May Need To Short Stocks To Earn Some Profit In 2022

December 27, 2021

| Fullerton Markets

You May Need To Short Stocks To Earn Some Profit In 2022">

US stocks are on track to end 2021 with another year of outsize gains. Many investors are not expecting a repeat in 2022.

The S&P 500 has climbed 26% so far in 2021, after rising 16% in 2020. Rip-roaring corporate profits and easy monetary policy have fuelled the run. Earnings growth is expected to moderate next year, and the Federal Reserve is pursuing plans to raise interest rates, chipping away at key supports for the stock market’s rally.

When rates are low, investors tend to load up on risk assets such as stocks to generate returns. When inflation accelerates and policymakers raise interest rates, the value of companies’ future earnings drops and investors have more alternatives for places to make money.

Rock-bottom interest rates early in 2020 helped propel equity valuations higher, and they have remained elevated in the months since. Many analysts and investors now believe that increasing rates are likely to keep valuations from rising further, and might cause them to fall.

Though stock indexes often continue to rise early in a cycle of interest-rate increases, the tighter monetary policy puts portfolio managers on a shorter leash and makes many of them guarded about taking on more risk.

The S&P 500 traded last week at about 21 times its projected earnings over the next 12 months, above a five-year average of a little less than 19 times, data shows. Some traders think the shift in monetary policy could help limit stock gains to levels more in keeping with their long-term trend.

The S&P 500 has averaged an annual gain of 8.4% from 1957, the year it was introduced, through last year. But it is coming off three much stronger years. The index jumped 29% in 2019, even more than its advances in 2020 and so far in 2021.

This month the Fed laid the groundwork for interest-rate increases starting as early as next spring and approved plans to wind down a bond-buying stimulus program more quickly. Democrats’ roughly $2 trillion education, healthcare and climate package face an uncertain future after Sen. Joe Manchin said last week he would oppose it.

So far, the consensus is forecasting smaller gains for the S&P 500 in 2022. Among 13 banks and financial services firms, whose analysts have published 2022 forecasts, the average target for the S&P 500 to end next year is 4940, about 4.5% above where the index closed last week.