Looking Through the Market Noise to 2022

Right now, global supply chain disruptions are roiling the delivery of goods everywhere, just as the demand for goods relative to services is peaking. Yet, looking ahead, a normalization for most of the economy is likely over the coming year, especially as government stimulus wanes. Near term shipping costs are very high, but delivery times are speeding up. This is a reliable sign of reduced costs to come.

As the economy rebalances, initial price spikes – including for services – may subside. News of effective new therapeutic COVID-19 treatments makes it more likely that this normalization could fully unfold during 2022. This seems under-appreciated by markets.

New bond market rate pressures and the sharp rise in US growth shares has set the equity market up for a rotation similar to the cyclical rally at the start of the year. To the extent that yields rise further, growth stock valuations may be challenged. That is because the US growth index trades at nearly double the valuation of US value shares and international equities. But Citi analysts suggest investors watch the realized EPS growth in certain groups closely. For sectors such as semiconductors, software and cybersecurity, EPS growth is likely to remain rapid.

Bond yields below 2% is unlikely to inhibit economic growth and is not a major hurdle for equity valuations. Short-term investor repositioning has caused the recent market rotation to cyclicals. Citi analysts believe that this is likely to reverse as manufacturing and commodity prices peak in the coming year. 

US equities have risen at a 23% annualized rate since COVID-19 struck. Citi analysts expect returns to retreat to the high single digits in the coming year, with short-term corrections along the way. Citi analysts do not expect another “everything rally” as we saw in the rebound from the 2020 low.

2022 Likely Positive for Equities, Not So Much for Bonds

Talk of Fed rate hikes is unlikely to derail the recovery, while supply chain related inflation indicators should start to abate next year. While fiscal spending globally is unlikely to match this year’s massive stimulus, Citi analysts believe a moderate amount of infrastructure and other social spending may be passed by the Biden administration, which could benefit select industries, while offsetting tax hikes should only shave 2-3 percentage points off of EPS growth next year. Taking all these factors together, Citi analysts expect a 7-8% annualized EPS growth over the next 2 years to sustain positive equity returns.