Markets rarely give us clear skies. There are always threats to watch for on the horizon, but the right preparation, context, and support can help us navigate anything that may lie ahead. So far, this year hasn’t seen a full-blown crisis like 2008–2009 or 2020, but the ride has been very bumpy. We may not be flying into a storm, but there has been plenty of turbulence the first part of 2022. How businesses, households, and central banks steer through the rough air will set the tone for markets during the second half of 2022.
The sources of turbulence are clear. A global economy already vulnerable to inflation from supply chain disruptions, tight labor markets, excess stimulus, and loose monetary policy came under more pressure when Russian aggression in Ukraine added sharply rising commodity prices and pushed Europe to what may be the brink of a recession. The effects have included renewed pressure on interest rates, which hurt bond investors and contributed to tightening financial conditions, and a much more aggressive stance by the Federal Reserve (Fed) and other global central banks. Add in the typical market challenges of a midterm election year and the third year of a bull market, and it’s not surprising it has been a bumpy ride.
Understandably, rising prices, slowing economic growth, and a challenging first half for both stocks and bonds have many investors on edge, and fatigue from more than two years of COVID-19 measures doesn’t make it any easier. But markets are always forward-looking, so it’s important to remain focused on what lies ahead. There most certainly will be challenges, but there also are some tailwinds from a strong job market, still resilient businesses, and the likelihood that inflation soon will start to slow. Markets historically even can get a little lift from lower uncertainty around elections as the midterms approach.
Turbulence cannot be avoided, but it also need not deter us from making progress toward our financial goals. LPL Research’s Midyear Outlook 2022: Navigating Turbulence is designed to help you assess conditions for the second half of the year, alert you to the challenges that may still lie ahead, and help you find the smoothest path for making continued progress toward your destination.
MIDYEAR OUTLOOK 2022: OVERVIEW
ECONOMY – We believe the domestic economy will grow slightly this year, albeit slower than we expected six months ago. We think the economy has sufficient momentum to offset the inflationary pressures. Our base case forecast includes an inflation rate that moderates as supply bottlenecks improve and we potentially get some closure to the Russian war with Ukraine. Our most likely scenario is slight growth in 2022, with growth under two percent in 2023. These are annual figures, so intra-year economic activity could be quite volatile as the Fed becomes more aggressive in the tightening cycle.
INFLATION – Inflation most likely will be significantly above the Fed’s long-run target of two percent. Inflation rates likely will cool throughout this year, but the cool-down period will be long and slow. Some inflation pressures should subside as China adjusts its COVID-19 policy and supply chains improve. A slowing housing market also eventually could ease inflationary pressures later this year and into 2023.
STOCKS – Stocks will face a number of headwinds in the second half of the year, but the amount of turbulence likely will depend on the pace at which inflation falls. Volatility may persist, but an improved macroeconomic environment may set the stage for higher valuations, further earnings growth, and solid gains for stocks during the rest of the year. The challenge comes from predicting how fast inflation will come down. Our year-end fair value target for the S&P 500 is 4,300 to 4,400, based on a price-to-earnings ratio of 18 to 19 and our 2023 S&P 500 earnings per share forecast of $235.
BONDS – The value proposition for core bonds is that they tend to provide liquidity, diversification, and positive total returns to portfolios. Unfortunately, none of those values is 100 percent certain all the time. Like all markets, fixed income investing involves risks and, at times, negative returns. However, despite the historically poor start to the year, the value proposition for core bonds actually has improved recently. With the big jump in yields that has taken place already this year, we believe core bonds look as good as they have in quite some time. As rate hikes work their way through the economy and slower growth starts to get priced in, we could see the 10-year Treasury yield end the year between 2.75 and 3.25 percent.
POLICY – One of the things we knew coming into this year was that 2022 is a midterm year – and those historically have not been kind to stocks. In fact, since 1950, midterm years have seen the largest peak-to-trough pullback of the four years of the presidential cycle, with the S&P 500 Index down 17.1 percent on average during the year. The good news is that one year off those lows, stocks have been up more than 32 percent on average. And the S&P 500 has been higher a year after every midterm election since 1950 – 18 out of 18 years – with an average gain one year later a very solid 14.5 percent. It looks like a divided government is in the cards, which markets historically have liked.
MIDYEAR OUTLOOK 2022: OVERVIEW
ALTERNATIVES – Losses across both stock and bond markets in 2022 have left many searching for ways to further diversify exposures. While alternatives cover a wide range of approaches, several have helped fill that gap, and may continue to do so during the rest of the year. We continue to believe preferred alternatives implementations – event-driven strategies, market neutral strategies, and relatively conservative low volatility strategies – have the ability to act as a source of ballast during such periods of high volatility.
COMMODITIES – Commodities have garnered support from both demand and supply, and we believe upward pressure on prices likely will persist for at least the next several months. Demand has gotten a lift as the global economy emerged from the pandemic. Sanctions on Russian energy exports have kept oil and gas prices elevated. Ukraine is an important global supplier of agricultural commodities such as corn and wheat, putting upward pressure on food prices. From an investment perspective, we would favor energy.
CURRENCIES – In the second half of 2022, the factors that led to a sharp and nearly uninterrupted ascent for the U.S. dollar such as a hawkish Fed and demand for safe havens may begin to reverse. In the intermediate term, easing inflation from unsnarling of supply chains post-COVID-19, aided by China’s reopening, could help push the dollar lower.
In conclusion, as we try to orient ourselves to what may lie ahead in 2022, it can be hard to get our bearings, especially when we feel buffeted about by forces that are either unique or that we haven’t experienced in some time. We still are dealing with COVID-19-related economic disruptions. Inflation is at its highest level in decades, central banks are trying to figure out how to unwind more than a decade of extraordinary monetary support to fight inflation, and Europe’s two largest countries are at war.
Ultimately, we believe the best path forward to navigating any environment, whether skies are clear or stormy, is having a thoughtful plan and the right support that can help get you safely to your destination, whatever bumps there may be along the way. Please reach out to your trusted financial advisor with questions about how to stay on course toward reaching your financial goals.
The LPL Financial Research team provided this information. LPL Financial is located in Chesterfield, Missouri. Contact Jonathan Benner, Certified Financial Planner™ with LPL Financial at jonathan.benner@lpl.com or 636.200.4204. To view the complete Midyear Outlook 2022: Navigating Turbulence, visit lplmycfo.com.