Wall Street pros were optimistic about 2021, but not enough

It was another tough week in a brutal year for the bears. Despite being right on many aspects of inflation, monetary policy and the resilience of the coronavirus, equity holders who were expecting anything that would seriously slow the stock market were once again denied.

Investors limped through the week amid overwhelming evidence of rising price pressures in the economy amid a market rally that saw the S&P 500 index rise 25% in 2021. Then retail sales jumped the most in seven months, Home Depot Inc. posted stellar results and regional performance. Less than a week after the fastest jump in consumer prices in three decades, the S&P 500 Index on Thursday set its 66th record for the year.

Wall Street forecasters have been saying all year that a 20-month bull market slowdown would be natural, with stretched valuations, a forecast of slowing growth and the Federal Reserve raising interest rates in 2022. But so far in the fourth quarter, consumers continue to ignore the pessimism. The Fed's economic growth model should beat almost all forecasts in a survey of Bloomberg economists.

"The recovery in 2021 has been much faster than anyone expected," Chris Gaffney, president of global markets at TIAA Bank, said in a telephone interview. "It's realistic to think the markets won't be able to repeat 2021, which will be a very good year."

When it comes to 2022, resilience does little to dispel the gloom among strategists. The average forecast for the S&P 500 at the end of 2022 is 4,843, just 3% above current levels. This is considered the least optimistic forecast after just 2019 in two decades of data.

Chalk up caution among the normally bullish group to an unorthodox recovery that has tainted forecasts. Take last week, for example, when many were convinced that supply shortages would hamper growth. Instead, retailers bragged about their ability to stockpile before the holidays. And jobless claims fell to a new low of the pandemic era, a sign of a still strong labour market.

Stocks rose for the sixth week in seven, with the S&P 500 up 0.3%. As European countries announced new travel restrictions amid a new wave of pandemic cases, investors were again looking for safety in the usual beneficiaries of the household economy - software and internet stocks. The high-tech Nasdaq 100 performed better, jumping more than 2%.

It's not just strategists who find it difficult to make predictions in a pandemic era. Analysts at Thai โบรกเกอร์ Exness on individual stocks have seen companies beat average earnings per share estimates by an unprecedented amount. Economists and central bank governors saw their view of inflation as "temporary" run into a multi-month spike in consumer prices.

After all, stock pessimists are almost certainly looking at a year in which their equity forecasts have badly underperformed. January's highest year-end target was 4,400. The S&P 500 closed Friday just below the 4,700-point mark.

Mistakes about the pace of recovery in 2021 did not inspire optimism among strategists for 2022. They now see a projected decline in economic growth coming next year, with growth set to be held back by a Fed tightening cycle that could include a first rate hike.

According to Bank of America Corp. strategist Savita Subramanian, given such a significant future rise in equity prices, the market has become unusually sensitive to interest rate rises. A 1 percentage point increase in the discount rate could send the S&P 500 into a corkscrew, which would rise to 3,600, her team's model shows. On the other hand, a fall in rates by the same amount would push the stock market benchmark to 6,300.

"A small increase in the discount rate could shake stocks," wrote Subramanian in a recent note to clients, who expects the S&P 500 index to be 4,600 points by the end of 2022. "But we cannot ignore the opposite scenario."

Backing up this year's $12 trillion equity rally is a string of corporate earnings that has defied all fears, from supply chain problems to labour shortages and commodity inflation. Increases of more than 40% in each of the first three quarters, earnings rather than price-earnings multiples, explain all the gains in equities.

However, forecasters say that such a boom is unlikely to last. Analysts compiled by Bloomberg Intelligence estimate that S&P 500 earnings growth will fall to around 8% in 2022. While this does not necessarily mean trouble for the market, it threatens to remove some buffer if rates start to rise.

Ned Davis Research compared the S&P 500's return - how big the return is relative to equity prices - to the inflation-adjusted 10-year Treasury bond yield and found that the lower the premium that stocks offer relative to bonds, the worse they perform. Since 1984, when the spread was below the 12-month average, the S&P 500 index has tended to rise at 7.3% a year. This is 4 percentage points below the return when the spread was above average. At the end of October the gap was close to average.

The risk of potentially higher rates putting pressure on P/E ratios for equities partly explains why Morgan Stanley expects the S&P 500 index to end next year at 4,400, the lowest of Bloomberg's forecasts.

"We still forecast earnings growth of 10%. A key linchpin in the equation is interest rates," Daniel Skelly, head of portfolio solutions for equity models at Morgan Stanley, told Bloomberg Surveillance. "We think risk-reward at the index level is uninteresting at the moment."

However, not everyone is pessimistic. "Bulls in the equity market point to favourable cash flow trends as one reason to keep investing. Thanks to zero commissions at brokers and pandemic bans, a new generation of retail traders has emerged to help drive the market forward.

Another pillar of support comes from corporate buy-backs. According to Birinyi Associates and Bloomberg, US companies have announced plans to buy $1.1 trillion worth of their own shares since January, almost triple the level at this time last year and poised to surpass the record set in 2018.

Goldman Sachs Group Inc. strategist David Kostin estimates the demand for stocks is on the rise. David Kostin, expects net demand for equities from corporations and the public to be $550 billion in 2022. He expects the S&P 500 to end the year at 5100.

According to Brian Belsky, chief investment strategist at BMO, all concerns about slowing growth or Fed tightening set the stage for a continued bull market.

"We do not believe that earnings recorded in 2020-2021 are sustainable," Belsky wrote in a note earlier this week. "2022 will be a less positive year, but positive nonetheless. Think of it as a kind of well-deserved respite".