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By Lu Wang November 20, 2021

  •  Strategists have underestimated S&P 500 rally, see tepid 2022
  •  Their forecast annual gain is second-smallest in two decades

It was another tough week in a brutal year for bears. Despite being right about many aspects of inflation, monetary policy and the persistence of the coronavirus, equity bears who were expecting anything to put a meaningful brake on the stock market were again denied. 

Investors limped into the week amid incontrovertible evidence price pressures are building in the economy amid a market rally that has sent the S&P 500 up 25% in 2021. Then retail sales jumped the most in seven months, Home Depot Inc. posted stellar results and regional manufacturing measures soared past forecasts. Barely a week after the fastest jump in consumer prices in three decades, the S&P 500 hit its 66th record of the year on Thursday.

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Wall Street forecasters have been saying all year that a slowdown in the 20-month bull market would be natural, with valuations stretched, growth forecast to slow and the Federal Reserve expected to hike interest rates in 2022. But so far in the fourth quarter, consumers continue to defy the pessimism. A Fed model of economic growth is on track to exceed almost all projections in a Bloomberg survey of economists

Only once before were strategists less bullish on the market than they are now

“The recovery happened much more quickly in 2021 than anyone had predicted,” Chris Gaffney, president of world markets at TIAA Bank, said in a phone interview. “It’s realistic to think that markets are not going to be able to repeat 2021, which will go down as a very good year.”

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The resilience is doing little to dissipate gloom among strategists when it comes to 2022. The average projection for the S&P 500 at the end of 2022 is 4,843, representing a mere 3% advance from the current level. That counts as the least optimistic outlook behind only 2019 in two decades of data.

Chalk up caution among the normally bullish group to an unorthodox recovery that has played havoc with forecasts. Take the latest week, when many were convinced strained supply would hamper growth. Instead, retailers were bragging about their ability to build inventories ahead of the holidays. And jobless claims fell to a new pandemic-era low, signaling a still-strong labor market.

Stocks advanced for a sixth week in seven, with the S&P 500 rising 0.3%. As countries in Europe announced new travel restrictions amid a fresh wave of pandemic cases, investors again sought safety in the usual beneficiaries of a stay-at-home economy — software and internet stocks. The tech-heavy Nasdaq 100 outperformed, jumping more than 2%.    

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Strategists are not alone in finding it difficult to make predictions in the pandemic era. Single-stock analysts have watched companies beat the average estimate for earnings per share by an unprecedented amount. Economists and central bankers have seen their view on inflation being “transitory” run into against a multi-month surge in consumer prices.

In the end, the stock pessimists are almost surely staring at a year where their forecasts for equities missed badly. In January, the highest year-end target was 4,400. The S&P 500 ended Friday just below 4,700. 

S&P 500 is ahead of strategists' year-end target

Being wrong about the pace of the recovery in 2021 hasn’t fostered optimism among strategists for 2022. They now see the predicted slump in the rate of economic growth occurring next year, with gains hampered by the Fed’s tightening cycle that could include the first rate hike since the pandemic began. 

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With so much future growth priced into equities, the market has become unusually sensitive to the rise of interest rates, according to Bank of America Corp. strategist Savita Subramanian. An increase of 1 percentage point in the discount rate could send the S&P 500 into a tailspin that takes it to 3,600, her team’s model shows. On the other hand, a rate drop of similar size would push the stock benchmark to 6,300.

“A small increase in the discount rate could roil equities,” Subramanian, who expects the S&P 500 to end 2022 at 4,600, wrote in a recent note to clients. “But we cannot ignore the opposite scenario.”

Helping underpin this year’s $12 trillion stock rally is a string of corporate earnings that has defied all the concerns ranging from supply-chain snarls to labor shortages and commodity inflation. Up more than 40% in each of the first three quarters, profits, rather than price-earnings multiples, have accounted for all the share gains.

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That kind of boom, however, is unlikely to last, prognosticators say. S&P 500 profit growth will weaken to roughly 8% in 2022, analyst estimates compiled by Bloomberg Intelligence show. While that doesn’t necessarily spell trouble for the market, it threatens to remove some buffer should rates start to creep up. 

Ned Davis Research compared the S&P 500’s earnings yield — how big profits are relative to share prices — to inflation-adjusted 10-year Treasury yields, and found that the lower premium that stocks offer over bonds, the worse they perform. Since 1984, when the spread was below its 12-month average, the S&P 500 tended to rise 7.3% a year. That’s 4 percentage points behind the return when the spread was above the mean. At the end of October, the gap sat near its average. 

relates to Wall Street Pros Were Bullish for 2021, Just Not Bullish Enough

The risk of potentially higher rates pressuring equity P/E ratios is partly why Morgan Stanley sees the S&P 500 finishing next year at 4,400, a forecast that’s the lowest among those tracked by Bloomberg.

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“We’re still predicting 10% earnings growth. The key linchpin in the equation is interest rates,” Daniel Skelly, head of equity model portfolio solutions at Morgan Stanley, said in an interview on  “Bloomberg Surveillance.” “We think risk-reward at the index level is unexciting at this point.”

Not everyone’s pessimistic though. Equity bulls point to favorable trends in money flows as one reason to stay invested. Thanks to zero commissions at brokers and pandemic lockdowns, a new generation of retail traders have emerged to help propel the market. 

Another pillar of support comes from corporate buybacks. U.S. firms have announced plans to buy $1.1 trillion of their own shares since January, almost triple the level at this time last year, and poised to surpass the record set in 2018, data compiled by Birinyi Associates and Bloomberg show. 

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Net demand for equities from corporations and households will total $550 billion in 2022, according to estimates from Goldman Sachs Group Inc. strategist David Kostin. He expects the S&P 500 to finish the year at 5,100. 

To Brian Belski, BMO’s chief investment strategist, all the worries over a growth slowdown or Fed tightening set the stage for the bull market to keep going.   

“We do not believe the returns registered in 2020-2021 are sustainable,” Belski wrote in a note earlier in the week. “2022 will be a year of less positive, yet positive, nonetheless. Think of it as a much-deserved respite of sorts.” 

— With assistance by Vildana Hajric, John McCorry, Tom Keene, and Jonathan Ferro