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The Wall Street Publication > Blog > Markets > Cheaper Stocks Boost S&P 500’s Prospects in New Year
Markets

Cheaper Stocks Boost S&P 500’s Prospects in New Year

Editorial Board Published January 2, 2022
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Cheaper Stocks Boost S&P 500’s Prospects in New Year
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Investors banking on a roaring bull market in U.S. stocks in 2022 are enjoying the company of an unexpected ally: valuations. 

The S&P 500 rose 27% in 2021, capping a third consecutive year of double-digit gains. Yet stocks are cheaper than they were a year ago: The S&P is trading at 21 times analysts’ projected earnings over the next 12 months, down from 22.8 times at the end of 2020.

Lower valuations, together with an expanding economy and ultralow interest rates, help explain why most Wall Street forecasters predict the S&P 500 will continue to rise in 2022, even as the Federal Reserve prepares to raise interest rates for the first time since the pandemic struck. Goldman Sachs, RBC, Wells Fargo, Credit Suisse and others predict the S&P 500 will rise between 6% and 11%.

“Earnings can’t maintain the 2021 pace, but it should still be a growing environment,” said Rob Haworth, a senior investment strategy director at U.S. Bank Wealth Management. 

A blowout year of corporate earnings was the story in 2021. S&P 500 profits rose 45%, the most since FactSet started keeping track in 2008. 

The coming year will be different, of course. Inflation is surging for the first time in a generation, potentially eating into profits. Fed rate increases will force investors to reassess the earnings outlook, and of course the Covid-19 pandemic will likely take further twists and turns.

All this means that profit growth will likely revert to more normal levels. The Wall Street estimate for S&P profit growth has fallen to 9% from 16% earlier in 2021.

Meanwhile multiples remain above their long-run average, though the ultralow level of interest rates helps to explain that, many analysts and portfolio managers say. 

“What else are you going to do? Putting money into bonds is dead money,” said Scott Ladner, chief investment officer at Horizon Investments. “Your best case is getting money out of the stock market, where there is earning power.” 

By BlackRock’s estimate, the yield on the benchmark 10-year Treasury note would have to approach 3%, up from a recent 1.5%, to entice investors to put their money into anything other than stocks. Even with expectations that the Fed will raise interest rates three times, many analysts see 10-year yields moving no higher than 2% or so. 

Some say the economic backdrop for 2022 requires a more nuanced strategy than buying S&P 500 index funds, in part because some sector valuations are at extreme ends of the spectrum. 

The S&P 500’s tech stocks are currently trading around their highest levels in nearly a decade at 28 times. Consumer-discretionary stock multiples have contracted from 2020’s all-time highs, but remain at 33 times, well above levels going back to 1999. For both, the combination of higher rates and lower earnings growth will likely keep a lid on outsize gains in the market’s growthier sectors, investors and analysts said.

Goldman’s analysts pointed to Hess in the energy sector as a stock poised to deliver above-average returns in the coming months.

Photo: Luke Sharrett/Bloomberg News

Meanwhile, some money managers and analysts say energy and financial stocks are relative bargains thanks to solid earnings growth helping to keep valuations in check, even as prices mostly rose across those sectors. 

The S&P 500’s energy sector trades at 11 times earnings, below average multiples. With analysts predicting a 26% growth in earnings for the sector over 2022, energy stocks appear to have further room to run following 2021’s 48% return for the sector.  Goldman’s analysts pointed to Hess Corp. in the energy sector as a stock poised to deliver above-average returns in the coming months. 

Financials, meanwhile, trade at nearly 15 times forward earnings. With rates as low as they have been, those stocks seem fairly priced, analysts and investors said. But several rounds of rate increases have the potential to dramatically lift the fortunes of financial stocks and their profitability around lending. But that is only as long as the economic environment remains robust enough to support a pickup in lending activity, some analysts added. 

Jason Brady, chief executive of $48 billion money manager Thornburg Investment Management, counts JPMorgan Chase & Co. and Visa Inc. as two of his picks for 2022. The former carries a below-market multiple, he said, while Visa remains positioned to benefit from continuing economic growth and is somewhat insulated from the threat of inflation. 

Small-cap stocks are also a favorite for several money managers, including Keith Buchanan, a portfolio manager at Globalt Investments. Mr. Buchanan pointed to the strengthening dollar as one reason to be optimistic on smaller stocks, especially on the value side. Others added that if the economy continues to strengthen, stocks across the Russell 2000 could be poised for a breakout from their more recent tepid performance. 

Overall, Wall Street observers are expecting a solid, but more muted, year of stock-market gains. 

“This year won’t be as good as last, but it won’t be horrible by any stretch of the definition,” said Mr. Ladner.

Write to Michael Wursthorn at [email protected]

Copyright ©2021 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8

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