Risks are high, but analysts are skeptical of a severe stock market downturn

A trader wears “2022” glasses while working at the New York Stock Exchange (NYSE) in New York, U.S., Friday, December 31, 2021.

Michael Nagel | Bloomberg | Getty Images

Inflation, central bank tightening and Covid-19 infection rates continue to threaten The stock market is bullish, but analysts largely don’t expect a severe pullback in 2022.

Last week, U.S. stocks had their second-worst start since last year. Lehman Brothers collapses, driven by further hawkishness from the Federal Reserve and a sell-off in high-valued U.S. tech stocks. The trend continued on Monday, with global stock markets falling again.

A key source of the hawkish surprise in the FOMC minutes’ latest meeting was policymakers’ desire to tighten their balance sheets, which Deutsche Bank analysts believe has been greatly underestimated by the market.

The rapid global spread of omicron variants of Covid-19 has also clouded the outlook for stocks in recent months, with record daily cases and tighter social restrictions in many major economies.

“The Omicron Covid variant could lead to more restrictions, but the economic recovery remains resilient, meaning stocks don’t seem particularly vulnerable to a correction,” Luca Paolini, chief strategist at Pictet Asset Management, said on Monday.

Paulini said a strong labor market, pent-up demand for services and healthy corporate balance sheets remained underpinning the global economic recovery. As such, Pictet is looking for opportunities to increase its equity weighting in 2022.

However, he conceded that despite strong GDP growth expectations, especially in the US and Europe, surging inflation does present some downside risks – and could peak in the first half of 2022, while prompting the Fed to raise interest rates by June .

While Pictet is optimistic about the outlook for equities, Paolini’s team has taken a tactically neutral stance on the asset class as a whole, given U.S. liquidity conditions have turned negative and equities continue to be highly valued.

James Solloway, chief market strategist at SEI Investment Management, made a similar tone last week, noting that GDP growth will slow, the labor market will tighten, inflation will peak, Covid will continue to have short-term negative effects, and the global economy should continue to manage through Periodic setbacks.

“While there has been some speculation in some areas of the financial world — such as meme stocks, SPACs, cryptocurrencies and NFTs — we haven’t seen the kind of speculative enthusiasm that portends a serious stock market correction in 2022,” Soloway said. .

While data to date suggests the highly transmissible variant of the omicron may not be as severe as previous iterations of the virus, Mazars chief economist George Lagarias said Thursday that markets should avoid other pandemic-related Complacency at the possibility of shock.

“We can’t let ourselves fall into the trap of trying to predict the endgame timeline when the next round is unknown. Right now, the risk is non-linear, but parabolic,” Lagarias said.

“All it takes is a new dominant variant with vaccine resistance to cancel months of global vaccination and throw forecasts out the window.”

U.S. Valuation Vulnerability

Lagarias also stressed that U.S. stocks in particular are expensive and concentrated — a feature that stood out in last week’s weakness in tech giants — but noted that investors currently have few alternatives to stocks.

A correction in risky asset prices is increasingly likely due to the central bank’s paradigm shift towards quantitative easing, where inflation persists, he said.

“All of this uncertainty is bad for business, but it’s still unknown how risk assets will develop because the drivers have been completely decoupled from all of the above for far too long,” Lagarias said.

“It could be that the ‘surplus liquidity’ and ‘no choice but equities’ arguments prevail, or it could be that the market goes into a ‘fear mode’ with higher long-term volatility.”

Invesco’s global market strategist Kristina Hooper includes a potential U.S. stock market correction in her top 10 predictions for 2022.

“U.S. stocks could see a correction in the first half of 2022, but I expect a relatively quick recovery,” Hooper said.

“The odds that we haven’t had a major correction in a long time have increased — and the increasingly likely fact that the Fed will begin to normalize monetary policy and possibly start raising rates in the first half of 2022.”