Market gains may be harder to come by in 2022, but it could still be a positive year

Published Wed, Dec 29 20212:43 PM ESTUpdated Wed, Dec 29 20216:48 PM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Markets could have a much bumpier ride in 2022, but stocks should still notch gains even with the Federal Reserve raising interest rates and the continued uncertainty about the coronavirus. One big wild card for markets is whether inflationary pressures continue to rise, since that could encourage central banks to be even more aggressive with interest rate hikes than expected. Tied directly to that is how Covid-19 continues to evolve, and how much it hampers economies and supply chains. "Obviously, we start out with this huge cloud hanging over our heads with the omicron variant spreading. We come into the new year with a lot of momentum," said Ethan Harris, head of global economic research at Bank of America Merrill Lynch. "Fourth-quarter growth is running at about 6%, but a rising risk is what happened under the delta variant. The economy was moving along nicely, then we got a soft patch." The fast-spreading omicron variant has driven the number of new daily cases to record levels in the U.S., but studies suggest it isn't as severe a public health threat as the delta variant . Consumers are expected to be somewhat more cautious about going out to restaurants and attending public gatherings. As 2021 winds down, the S & P 500 is hitting new highs and has notched a 27% gain for the year. But strategists mostly see single-digit gains for 2022. The median target of strategists surveyed by CNBC is 5,050 for the S & P 500, slightly more than 5% over its current level. "I think it's going to be a fairly mixed year with a lot of volatility," said Jimmy Chang, chief investment officer at Rockefeller Global Family Office. "I think, based on historical patterns, it's probably going to be an up year on the assumption that we don't have a recession around the corner... I would be happy with high single-digit growth next year." Covid concerns The course of the coronavirus could also determine the path for stocks. Nomura economists cautioned there could be a slowing in consumer activity and job growth due to the spread of the omicron variant. "The latest COVID surge is likely to weigh on near-term service activity and NFP growth, but we expect that impact to begin to reverse in Q2 2022," they noted. "However, the inflationary impact of omicron could be longer lasting as the recovery in supply chains, labor supply and normalization of goods consumption are delayed, helping to keep the Fed hawkish." Bank of America's Harris said it's too soon to tell what type of impact omicron will have. "Given how contagious this is, there's going to be a lot of quarantining going on. That's going to put a lot of sand in the gears of the economy," he said. Harris said the problem would be if the virus causes a shock that slows growth while also boosting inflation. For now, he expects the economy to grow by 4% next year. Sam Stovall, chief investment strategist at CFRA, said historical patterns would have forecasted a strong stock market for 2022. But he expects the S & P to reach near the median forecast at 5,024. "If we did not have omicron, because 2021 was a great year, meaning more than 20% growth in price, it implies a good year," Stovall said. "Whenever we've had a 20% gain or more in one year, the market rose an average 10.4% in the next year." That performance is based on the S & P 500, going back to 1945. He said omicron is a potential problem for the market, but investors seem to be looking past it. "Because the market continues to rise, I think investors are saying omicron will continue to cause problems, represent headwinds to those groups that are travel- and leisure-related. Airlines, cruise ships, restaurants, all that stuff is going to be challenged," he said. "We're finding that companies are learning to work around these supply chain disruptions," Stovall added. "I think one reason why the Santa rally at least is getting off to a good start, I think in general investors are saying it's a short-term headline event. It's not a long-term bottom line event." The Federal Reserve and inflation The big event of the year for markets is the widely anticipated move by the Federal Reserve to tighten policy. Some economists expect the first quarter-point rate hike could come in March, and then be followed by two more. Indeed, central bank officials are projecting three rate increases next year. But as investors watch the Fed, they are also going to be keeping an eye on inflation. That may also alter the course of the central bank, either speeding it toward more rate hikes or allowing it to slow down. "Our expectation is inflation will peak in January 2022," said CFRA's Stovall. But others expect a peak later in the year, plus a continued rise in prices into 2023 and possibly 2024. "There's disagreement about inflation and disagreement about the Fed's response to inflation," he said. The concern is that inflation can eat away at capital and confidence, though some companies are able to pass along price increases and have protected their margins. Bank of America's Harris said he expects inflation to come down over the course of 2022 but not to a comfortable level. "The question is not whether inflation is going to ease back down. The question is to what," he said. He expects inflation to be in the high 2% range in two years. "Next year, we'll end at 3% and the following year, it will drop a little further. That's because some of the shortages are being resolved." The Fed has targeted 2% for inflation, but has said it would be tolerant of levels above that rate for a period. The consumer price index surged 6.8% in November and could be just as high in December. Indeed, consumer prices could continue to rise into the early part of 2022. "There's something fundamental that happened here. Part of it is psychological. They're seeing all these price increases. They're listening to a central bank that says they want inflation. People believe inflation is here. It's not something from the 1970s," Harris said. As for stocks, Harris does not think the market will have a negative reaction to Fed rate hikes immediately. He expects the first rate increase in March and then a hike every quarter for nine quarters in a row. "That's a very gentle tightening at least for the first year or so and shouldn't impact the market," Harris said. "I don't think the equity market should be worried about the Fed, at least initially. It's really if the Fed changes gears and says 'inflation is much higher than we expected.' That would be problematic for markets." Bank of America's equity strategists expect a flattish year in 2022.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, December 7, 2021.

Brendan McDermid | Reuters

Markets could have a much bumpier ride in 2022, but stocks should still notch gains even with the Federal Reserve raising interest rates and the continued uncertainty about the coronavirus.