Happy New Year! While many of us are starting off 2022 working from home once again amid sky-high COVID cases, the markets so far are picking up where they left off in 2021, with continued gains and rotation from high multiple stocks to value and reopening trades. After a standout +29% return year for the S&P 500 (and three consecutive years of double-digit returns) it makes sense to wonder if a host of challenges might derail this year’s returns and lead to a correction.
There is enough to worry about (COVID disruptions, bottlenecks, high inflation, Fed rate hikes, and more) but corporates and consumers will be tackling these challenges in 2022 from a position of strength: The ramped-up levels of corporate immunity, household immunity, and medical immunity should give the markets the firepower needed to overcome the challenges ahead. In this week’s commentary, we discuss three pillars of strength that should prompt investors to return to the markets this year with reinforced conviction and why investors could also return over time to the themes of tech and innovation that are under pressure again this week.
In the next few weeks as we embark upon the Q4 ’21 earnings season, we’ll be reminded about how strong and resilient global corporations have been and are. The S&P 500 companies are likely to report +21% Q4 ’21 earnings and +45% earnings per share (EPS) growth for all of calendar year 2021.1 This would also mean that S&P 500 calendar-year EPS is 25% higher than that of calendar year 2019,2 despite the many waves of the pandemic, an inflation surge, labor cost shortages, and more. This should reinforce investor confidence in companies’ ability to adapt and navigate difficult environments.
Because of this resiliency, cash on corporate balance sheets globally is hovering near an all-time high of $6.8 trillion.3 With companies and consumers increasingly moving beyond the crisis, there is a good chance this cash could be deployed toward more share buybacks and dividend increases. Indeed, share buybacks and stock repurchase plans could reach $872 billion for 2022.4 This abundance of cash should also continue to support a robust mergers and acquisitions (M&A) environment.
Together, corporate strength and solid economic growth should mean low defaults – expected to be 0.75% in 2022 – which should keep credit spreads in check.5 Even if the Fed hikes rates three times as expected, 89% of S&P 500 debt is fixed versus floating rate,6 and would not reset higher even if the 10-year Treasury continues to rise.
U.S. household net worth reached $145 trillion as of Q3 ’21, +24% above 2019 levels.7 This wealth was created through stock market and housing market appreciation, as well as through the IPO and M&A boom of 2021 as private company stakeholders monetized their positions. Government support helped too. Of course, no one likes that inflation today is at a 40-year high, but with wage increases expected to grow at their best levels since 20088 9 and aggregate household net worth at a record, consumers too are starting this year on strong footing and are unlikely to pull back on consumption despite inflation. Indeed, consumer spending, which makes up two-thirds of U.S. gross domestic product, is forecast to grow 2.9% in 2022.10
Most forecasters agree that 2022 will be the year when the global pandemic will finally shift to the endemic status. Why? Because the aggregate achieved level of population immunity against COVID has significantly risen such that sooner or later the virus (mutating or not) should start running out of targets to infect or make seriously ill. As an example, in the UK either through vaccination or infection (or both), 94% of the population (aged 15+) has acquired a level of immunity.11 Similarities hold in the United States and elsewhere globally. For example, in the United States, 204 million individuals are fully vaccinated and there have been 53 million infections cumulatively (a number that is likely a big understatement).12 Globally, 58% of the world has received a first dose of the vaccine.13
From a medical perspective, this level of aggregate population immunity should mean that the level of infections should stabilize rather than show big, unexpected spikes. This would mean we have reached an endemic phase. From a public policy perspective, health experts, governmental bodies, and the public could collectively decide that given this level of immunity (especially if we continue to see a decoupling of cases and hospitalizations/deaths), we are comfortable with accepting the level of impact the virus has and that it no longer constitutes an active crisis. Bottom line, we believe that 2022 could finally be the year when COVID-19 no longer controls, dominates, and defines our lives.
Tech and innovation themes could shine again
The year-end rally was light on volume and volatility. We think investors could return more decisively to the equity markets with reinforced conviction given the three areas of strength and confidence above. The question is – which part of the market should they be returning to?
Many of last year’s winners may not look quite as attractive, in our view – financials might be challenged by the flatter yield curve; semiconductors may see revenue growth slow; pandemic trades will likely be forgotten; travel reopening trades are no longer cheap and reopening scenarios (like resumption of business travel) is largely priced in; supply chain issues may still weigh on industrials; and low margins and rising wages may challenge the consumer services sector.
Against that backdrop, we think Info Tech growth stocks are worth another look. Parts of tech – particularly growth and innovation stocks — got hit hard toward the latter part of 2021 and again this week, with many stocks in this space down 30%-50% from their 52-week highs, while the S&P 500 closed the year at an all-time high.14 After all the hype, extended valuations, and the hawkish Fed pivot, valuations for parts of tech reset lower.
History suggests, however, that the Fed rate hikes do not spell ruin for tech stocks and multiples do not contract materially (they don’t rise either) in a rising rate environment. Rather, earnings growth and high margins are the key drivers of performance. For example, Nasdaq outperformed the S&P 500 in three out of the last four rate-hiking cycles.15 And on average, Info Tech stocks outshined Financials in the year of the first-rate hike.16
Within Info Tech specifically, we see opportunity in Cybersecurity. Cybersecurity stocks are down -10% from recent highs and valuations on many have reset lower – price-to-sales ratios fell from 11.9x to 9.3x between November 9, 2021, and today.17 This is a buying opportunity for reasonably valued security names. Cybersecurity is a top concern for everyone right now and security spend is set to outpace broader IT spend well into 2024, with an estimated compound annual growth rate of 9.4% versus 4.9% for broader IT spending. With more and more work becoming digital and moving to the cloud, IT managers will prioritize spending on cloud security, identity access management, and endpoint protection.
(1) Source: Factset, as of December 17, 2021.
(2) Source: Factset, as of December 17, 2021.
(3) Source: Wall Street Journal, S&P Global Data, as of August 2021.
(4) Source: Goldman Sachs Research, October 29, 2021.
(5) Source: JPMorgan, Default Monitor, December 1, 2021.
(6) Source: IPE, US Equities, May 2018
(7) Source: Board of Governors of the Federal Reserve System, December 9, 2021.
(8) Source: Conference Board Salary Increase Budget Survey, December 7, 2021.
(9) Note: Based on the Conference Board survey, companies are expected to raise wages by 3.9% in 2022 which would mark the highest yearly raise since 2008.
(10) Source: Goldman Sachs Research, January 3, 2022
(11) Source: Financial Times, as of December 10, 2021. Based on data sourced from UKHSA and the Cambridge MRC Epidemiology Unit.
(12) Source: OurWorldInData, as of December 30, 2021.
(13) Source: OurWorldInData, as of December 30, 2021.
(14) Source: Bloomberg, as of January 3, 2022.
(15) Source: iCapital, as of January 3, 2022.
(16) Source: iCapital, as of January 3, 2022.
(17) Source: Bloomberg, as of January 3, 2022
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