‘Event’ Risk

Most equity forecasts for 2022 are constructive. Even the “bearish” calls aren’t properly bearish.

Morgan Stanley’s Mike Wilson, for example, sees a 7% correction by year-end 2022. That counts as pessimism these days.

And yet, one does get a sense from perusing year-ahead outlooks that Wall Street is coalescing around a view that additional upside for US shares might be front-loaded (or back-loaded, to the extent the final weeks of 2021 deliver a portion of the expected additional gains).

Market participants who’ve been around longer than a few years are almost totally apathetic when it comes to bank forecasts for equity benchmarks. They (the forecasts) will be revised again and again throughout the year — marked to market, as it were. On the rare occasions when someone manages to “nail it” 12 months in advance, it’s just as much a testament to luck as it is to any kind of prescience.

That’s not to say year-ahead outlooks aren’t worth skimming. They are. In part because you don’t want to crunch the numbers that go into the forecasts yourself and if you’re willing to wade through dozens of pages, you’ll invariably come across some good charts and useful macro color.

In any case, the common thread around front-loaded gains is notable, if for no other reason than it speaks to collective apprehension about Fed tightening and ambiguity surrounding central bank policy in an environment of persistently elevated inflation.

Although UBS sees the S&P reaching 5,000 in the first half, they expect the benchmark to decline thereafter, ending 2022 at 4,850. “Persistent wage growth and increasingly exhausted offsetting levers starts to weigh on margins,” the bank’s Keith Parker said, describing what the operating environment might look like for corporate America as the second half of 2022 dawns. “Financial conditions continue to tighten [and] the midterm elections start to matter.”

Notably, UBS calculated that stocks typically rally 12.5% in the year prior to Fed liftoff, but after that, the fate of stocks depends heavily on the rapidity of rate hikes and inflation.

“Hikes triggered by high inflation have seen the S&P fall 7.5% on average over the next four months,” Parker remarked, referencing the figure (above).

JPMorgan’s Dubravko Lakos-Bujas called a hawkish shift from central banks “the key risk” to the outlook for US stocks. As a reminder, JPM’s 2022 S&P target is 5,050. The implied upside is predicated on expectations for “continued robust earnings growth as labor market recovery continues,” the notion that consumers “remain flush with cash” and assumptions about an easing of supply chain issues and an accelerating inventory cycle.

Lakos-Bujas went on to say that “most of the equity upside should be realized between now and H122, when monetary and fiscal policy tailwinds will be strongest, followed by sideways action in the second half.” He cautioned that “Fed liftoff could drive some de-risking and intra-cycle correction.”

BofA’s Michael Hartnett, meanwhile, suggested selling rips into what he continues to insist will be a “rate shock” in the first half of next year.

While it’s certainly understandable that strategists are wary of policy tightening, especially vis-à-vis a US equity market that’s propped up (or maybe “hopped-up” is better) on deeply negative real rates, one might gently suggest that the subtle tendency for investors to reclassify COVID as a source of ambiguity rather than a source of risk, is itself a risk.

That’s especially true when you consider the distinct possibility that additional virus waves and attendant restrictions could actually worsen inflation and thereby pile more pressure on central banks to tighten policy assuming the inflationary pressures associated with additional supply chain disruptions and prolonged labor market frictions outweigh any deflationary impulse from demand destruction.

Whatever the case, Hartnett is always keen to remind market participants that Fed tightening cycles typically don’t end well.

The figure (above) will be familiar to anyone who follows Hartnett’s weeklies.

“[We’re] forecasting ‘spreads up and stocks down'” in the first half of 2022, he said last Thursday, adding that historically, Fed tightening cycles end with a financial ‘event'”.

Needless to say, The White House wouldn’t be amused with any kind of “event” just months ahead of the midterms. But Joe Biden would be similarly vexed if Jerome Powell doesn’t do something to help push down inflation. And therein lies the tension that will likely define the new year.