Key Questions: What’s the Outlook for US Equities in 2022?

Stephen Hoedt, Managing Director, Equity & Fixed Income Research, KeyBank Investment Center, December 2021

Key Questions: What’s the Outlook for US Equities in 2022?

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Next year will NOT be a year to “set it and forget it.” – Stephen Hoedt, Managing Director

As the economic cycle migrates from midcycle to late cycle, we believe that 2022 will be a much more difficult year to navigate than 2021. Growth and inflation suggest that we are already late cycle; however, a host of indicators such as sector/industry leadership, style factor performance, and the shape of the yield curve suggest that further upside for equities lies ahead.

Inflationary pressures are likely persistent, and the Federal Reserve (Fed) now seems to be acknowledging this, possibly setting the stage for a policy error if the members are forced to move more quickly than anticipated to tighten policy to crush inflation. In fact, the recent increase in volatility is likely just as much, if not more, the result of market participants changing their perception of the pace of removal of policy accommodation due to the reemergence of the uncertainty from the omicron variant.

It is likely that omicron is more transmissible than other COVID-19 variants, but early reports out of South Africa suggest it also may be less deadly. That fits the pattern of virus evolution. Should these trends be confirmed in the coming weeks, we believe that the omicron variant could prove to be a positive for stocks if it accelerates the end of the pandemic.

How so? If a less severe and more transmissible virus – potentially such as omicron – crowds out more severe variants, then the COVID-19 pandemic would morph into something more like the seasonal flu.

That development would fit patterns of previous respiratory virus pandemics and make things such as case counts largely irrelevant going forward. Government restrictions imposed in the name of combating the virus, which place additional economic burdens on consumers and corporations, would be taken off the table. We will have reached the end game. Time will tell if this more optimistic view is correct, but we are confident and hopeful.

Earnings Outlook

We see earnings growth of 8% for the S&P 500 in 2022, a clear deceleration from the past two years. However, this growth deceleration is precisely what investors should expect as the economic cycle matures.

We see three clear positives supporting earnings:

  1. Persistent, above-trend goods consumption fueled by the most substantial household balance sheets in a generation.
  2. Corporate balance sheets flush with cash supporting both stock buybacks and capital spending.
  3. Less of a headwind from fiscal policy now that corporate tax hikes are unlikely.

But there are these potential negatives:

  1. Supply chain bottlenecks continue.
  2. The Omicron variant situation worsens.
  3. China’s economy slows more than anticipated.

Pulling all this together, our base case is for modest earnings growth.

S&P Return Scenarios

With earnings up but muted, our expected return scenarios for stocks are also muted. Historically, we see evidence of a stable price/earnings multiple around previous Fed tightening episodes, so we expect that gradually rising real rates will be offset by a falling equity risk premium. That would keep the current S&P 500 21.5 times P/E multiple unchanged in both our base case (3.3% price return increase for the 2022 calendar year) and bull case (up 10.3%) scenarios. Upside in 2022 will need to come from better-than-expected earnings, not multiple expansion. The bear case (down 17.0%) is predicated on the Fed needing to be more aggressive with tightening credit to fight inflation, pressuring profit margins while simultaneously hampering growth.

Earnings growth was not correlated with the level of inflation during the 1970s and 1980s but was positively associated with changes in inflation after controlling for economic growth. This suggests that the bear case is not a high probability outcome next year.


However, we do not see a high probability of a bullish upside surprise with the market navigating the transition to late-cycle dynamics with a hawkish Fed. Can you say “muddling through 2022” three times fast?


We continue to see some cyclical sectors and industry groups outperforming for much of early 2022 because of the inflationary backdrop: banks (with rates moving modestly higher over the next six months or more), REITs, energy, and metals and mining. Cyclicals such as industrials and consumer discretionary that are impacted by supply chain issues are not likely to outperform, however, so we believe that it pays to be selective here.

As the year progresses, we believe that high-quality growth, led by information technology and health care, could be poised to come back into favor. So 2022 should prove to be a year of transition as the economic cycle matures, buffeted by inflation and the Fed’s response. Accordingly, investors will need to be nimble in order to navigate a potential shift in market leadership as the year progresses.

In short, we do not believe that it will be a year for “set it and forget it” portfolio management, as we foresee an environment where active management and prudent risk-taking are likely to be rewarded.

For more information, please contact your advisor.

Stephen Hoedt Biopic

About Stephen Hoedt

Stephen Hoedt is responsible for the oversight of our internally-managed strategies, individual equity due diligence, equity trading, and both taxable and municipal fixed income due diligence with an emphasis on credit research. Within the Equity Research team he is responsible for coverage of Energy, Industrials, and Materials.

Prior to joining Key, Steve was the Industrials and Materials Analyst for the National City Corporation’s Private Client Group. He began his investment career in 1993 as an equity research analyst with responsibilities for the computer hardware and software industries.

Steve has been quoted in several publications including Barron’s and The Wall Street Journal, and has also appeared on CNBC and Bloomberg TV.