2022: What I See Coming for the Stock Market and More

This is my last Bauman Daily of the year. As is customary on such occasions, herewith I present my predictions for 2022 …

The Market Context

External factors have been the primary driver of stock market performance for the last decade. So, it’s critical to consider what might happen to those factors next year. Here’s what I think.

The omicron variant of COVID will turn out to be the first in a series of more contagious but less deadly variants. The disease will still affect the economy, but people will adapt to its presence. Shutdowns and travel restrictions will disappear. But long-term adaptations, especially travel reduction, working from home and avoiding crowded venues, will persist.
The Federal Reserve will wind down its quantitative easing program as planned. By the end of the first quarter, it won’t be buying financial assets anymore. In the fourth quarter, it will start running down its massive balance sheet by selling Treasury bonds. The Fed will hike interest rates three times by 0.25% each.
The end of COVID-era federal stimulus programs will lead to a significant decline in consumer demand, especially for physical goods. Increased spending on services will make up for some of this, rebounding sharply in the spring. Overall, economic growth will slow, but still be faster than the 20-year average. Inflation will decline to between 3% and 4% by the fourth quarter (but see No. 5 below).
The battle against COVID will shift from vaccines to antiviral pills to prevent serious sickness. This year’s debate over the ethics of rich countries hogging vaccines will shift to antivirals. There will be one or two new applications of mRNA vaccine technology targeting chronic infectious diseases.
There’s a 50/50 chance that Russia instigates a shooting conflict with Ukraine. If it does, it will be in the fall, just prior to winter. If that happens, and NATO and the United States respond with sanctions, Russia will cut natural gas supplies to Europe, leading to an energy crisis and soaring worldwide prices. That could lead to a rebound of inflation.
The Chinese Communist Party will intensify its crackdown on domestic capitalism. Chinese capital markets will continue their gradual separation from the rest of the world. China’s property sector will remain in decline, putting stress on balance sheets from household to central bank. But the People’s Bank of China will do whatever is necessary to avoid a sudden collapse.
The Democrats will be wiped out in the midterms, losing both the House and the Senate and numerous state legislatures and governorships. Once in control, the Republicans will shift focus to investigations of the Biden administration and changes to electoral systems. The federal government won’t enact any major legislation, either before or after the elections.

The Stock Market

As much money flowed into stocks in 2021 as the previous 20 years combined. That can’t continue, especially as Fed and federal stimulus evaporate. So, the big theme for 2022 will be a withdrawal of liquidity from stocks and other financial assets like crypto. Part of that will be retreating retail traders who’ve run out of cash or face margin calls. Another big driver will be a shift into bonds — particularly longer-dated ones.
The focus will shift from multiple expansion to quality, especially earnings and margins growth and market share. There will be an overall derating of the market, with an excessive price-to-earnings ratio and other valuation metrics falling. Companies with strong free cash flow and rising dividends will provide great opportunities. But valuations will quickly become excessive, so shop early in the year.
The top six U.S. companies, which account for 52% of market capitalization, will see their share prices stagnate for much of the year, as earnings growth slows to normal levels.
On the other hand, the small and mid-cap growth segment will find its bottom in the first quarter and begin to recover. Some of the most beaten-down stocks this year will see high double-digit gains in 2022. Again, however, the focus will be on quality and growing earnings. Companies with exciting ideas who are transitioning to production will struggle. That includes many in the electric vehicle sector.
These four factors mean the overall market index will grow less than 10% in 2022. But more stocks will keep up with the index than in 2021. Volatility will reduce. The combination of volatility-based trading strategies and corporate buybacks will provide a floor under stock prices. Unless there is a black swan event, we shouldn’t see major pullbacks.
Despite repeated attempts to recover previous highs, overvalued assets in the stock market, in crypto and in the startup sector will struggle. Some of 2021’s high-flyers, like Tesla and bitcoin, will continue to slide as speculative money evaporates.
The Securities and Exchange Commission will crack down on special-purpose acquisition companies (SPACs). It will launch a round of investigations, resulting in new rules about premerger performance claims.
Stocks that stand to benefit from the infrastructure bill will enjoy market-beating gains. But they will quickly become overpriced as investors search for returns anywhere they can. That’s why we’ve already positioned ourselves in the best of these early in The Bauman Letter model portfolio.
After struggling in the first quarter because of the failure of the Democrats’ Build Back Better agenda, renewable energy stocks will begin to recover. But the most reliable gains will come from the midstream sector, especially utility-scale power generation, transmission and above all, energy storage. We are ready to grab these gains in our Bauman Letter model portfolio. Speculative stocks, especially in battery technology, will struggle.
Stocks of companies that have suffered because of microchip shortages will begin to recover as conditions normalize. We’ll see significant gains in legacy automobile manufacturers, as they continue their rapid transition to renewable-powered vehicles.
As interest rates rise, housing prices will gradually fall. That, combined with a normalization of supply constraints in building materials, will lead to a recovery in residential construction companies, as well as real estate investment trusts (REITs) focusing on residential rentals.
The search for adequate supplies of minerals needed for renewable energy will come to dominate commodity markets. The pace of exploration for new deposits of minerals like lithium and cobalt will increase rapidly, presenting opportunities for sharp-eyed investors.