April 2022




WEALTH MONTHLY - 202204
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US Equities

We have been forecasting that US equities would produce subpar returns in 2022. We set our year-end target for the S&P 500 Index at 4,850. That was only 2% higher from where the index was at the start of the year. Two percent is substantially less than the average historical return of the S&P 500. Since 1957, it has produced an average annual return (including dividends) of 10.7%. Our 4,850 target was also lower than the targets of a large majority of the Wall Street firms. Even though we were still predicting a gain, we were definitely in the pessimistic camp.


We thought 2022 would be a below average year for US equities for several reasons. Stock market valuations (by that we mean average price-to-earnings and price-to-book ratios) were high, and earnings growth was slowing down. However, most importantly, we thought US stocks would have an off year because the US Federal Reserve was getting ready to tighten monetary policy. The S&P 500’s last bad year was 2018, which was also the last year the Fed shrunk its balance sheet and hiked interest rates.


The S&P is down about 6% year-to-date (ytd). It makes sense that the market is down. In fact, it is almost surprising that US equities are not down more. Policymakers at the Fed seem to be getting ready to tighten monetary policy much more than was expected just three months ago. Financial markets are now pricing in that the Fed funds rate will be over 2.2% by the end of this year. In January, most Wall Street forecasters were predicting that the Fed would only increase short-term interest rates by 75 basis points (bps) this year. Also, it now appears that Fed will begin reducing its balance sheet much more aggressively than anyone expected at the beginning of the year.


Meanwhile, the Ukraine war has caused commodity prices, especially energy prices, to skyrocket. There might even be shortages of natural gas in Europe. Higher raw material prices are going to hurt economic growth in many countries around the world. China’s economic growth is going to be slower this year than originally expected for various reasons, including Covid lockdowns. One of the attractions of US shares is that they are global companies. However, in this case, being global means they will be exposed to slower global growth. Tighter monetary policy and a slowing global economy do not seem to be a good combination for equity markets.


Investors need to now decide whether US equity investors are ignoring an approaching hazard, or whether the S&P 500 has already priced in the negative impact of high raw materials prices and a very hawkish Fed, and maybe things are going to prove to be less bad than feared.


We could get a ceasefire between Russia and Ukraine in the next several months. A ceasefire would likely lead to a decline in commodity prices and a big bounce in global equities. It’s not likely, but it could happen.


A more likely surprise would be that the Fed will not raise rates as much as Fed fund futures currently indicate. Policymakers are presently sounding very hawkish. Their speeches are intended to get fixed income markets to do the work of tightening monetary conditions now, rather than wait for the actual hikes. If this jawboning works, policymakers may not need to raise short-term interest rates as quickly, an event that would likely send equity markets higher.


We are sticking to our 4,850 target for the S&P 500. That is 7% higher than todays’ level, and would result in a very acceptable return for investors over the next 9 months. However, tactically, investors may not want to add to their US equity positions today. We believe 2022 is going to continue to be a volatile year. Investors may have an opportunity add at lower levels than today.


Last month we wrote that our US stock selection list is a good place to find individual stock and ETF ideas for investors who wanted to nibble on US stocks. In hindsight, we wish we had suggested investors do more than just take a nibble. US equities have been trending higher over the last 30 days. On average, the stocks on our US selections have outperformed the broad market this year, helped by video game company Activision Blizzard (ATVI US, +19.2% ytd) and fertilizer company Mosaic (MOS US, +88% ytd). We recommended taking profit on Activision Blizzard after it received a takeover offer from Microsoft (MSFT US). There is a significant risk that deal might fall through on anti-trust concerns.


We recommended Mosaic last year. Mosaic was already benefitting from high fertilizer prices at that time. However, since the war in Ukraine began, fertilizer prices have gone stratospheric. Russia and Belarus are major exporters of potash, Mosaic’s main product. Despite Mosaic being up 88% since we recommended it, we still think the share has not completely priced-in how good the fertilizer business is likely to be this year