2022 Stock Market Drivers: Trends and Expectations

By Mike Dickson, Head of Research and Product Development


2022 Stock Market Drivers: Trends and Expectations

By Mike Dickson, Head of Research and Product Development

A Framework to Help Simplify Market Complexity 
Understanding stock market behavior on a daily basis is usually an exercise in frustration. Many moving parts seem to drive prices. And just when one part seems dominant, the paradigm shifts. Prices are a constant discounting mechanism, fluctuating due to changes in expectations, not because of what we already know.

Still, market movements are not as random as it might sometimes seem. In looking for potential global equity market drivers for 2022, Horizon’s research team performed an analysis of both expected and past trends of company valuations and earnings growth – the two larger inputs into equity prices.

In essence, we’re attempting to separate the longer-term signals from the day-to-day noise. Earnings growth, in our view, is the key long-term driver of returns, while valuation adjustments tend to be more speculative and rule the short-term. The result of our analysis? Horizon’s view of 2022 supports balanced regional and style equity market exposure with cautious optimism about valuation expansion.

Covid Accelerated Existing P/E Valuation Expansion Trends
S&P 500 returns were strong versus global peers before the pandemic began and became even stronger during Covid’s spread. What seems lopsided in terms of performance, in fact, matches well with economic theory. Investors should be willing to pay more for every dollar in earnings as either interest rates fall, perceived risk decreases, or growth expectations increase. All three of those variables were reflected in how equity investors viewed the S&P 500 and S&P growth stocks compared to international and S&P value stocks.

Pre-Covid trends from 2010 to 2019 show price-to-earnings ratio (P/E) expansion contributing just over 3% per year for the S&P 500 and just over 4% per year for S&P growth stocks. P/Es expanded in international markets and S&P value stocks, but by a smaller amount.

The Covid-induced shock roughly doubled the P/E contribution to the performance of the S&P 500 and S&P growth stocks from the start of 2020 to the third quarter of 2021 (Figure 1). In light of the drop in interest rates and uncertainty caused by Covid, we view the P/E expansion as reasonable and rational.

Equity Valuations Supported by Low Bond Yields
Equity valuations are more than just a function of price and earnings, of course. We can also compare the equity earnings yield relative to 10-year Treasury yields to see which market might be more attractive.

Current relative valuation ranks the S&P 500 “cheaper” than bonds, with their relationship at roughly the 65th percentile in data going back 30 years (Figure 2). Given this historical perspective, stocks appear to be a better choice than bonds when an investor is considering where to invest their next dollar. And given our expectations for the Fed for 2022, if the central bank does take a dovish stance, it may lend further support to equities over fixed income.

EPS Growth Rates Show How Much Regional and Style Allocations May Matter
Not only have the S&P 500 and S&P growth stocks been dominant in terms of P/E expansion during the pandemic, they’ve also been delivering on the bottom line.


The earnings trend that favored the S&P 500 and S&P growth stocks pre-Covid accelerated as economies were shut down and work moved online. From 2010 to 2019, S&P 500 earnings growth averaged 8.5% per year compared to 2% for international stocks. From the start of 2020 through 3Q of 2021, those rates increased to 12.4% and 6.7%, respectively (Figure 3). For S&P growth stocks, the pace of earnings growth doubled from a 9% annual average pre-Covid to over 18% since 2020 began. To us, that shows earnings growth has been the primary driver of the outperformance of the S&P 500 and S&P growth stocks.
2022 EPS Expectations Are Not Overextended
“The trend is your friend,” goes the stock market saying. With 2022 earnings growth projections for the S&P 500 and S&P growth stocks projected to outpace international and S&P value stocks, respectively, it’s understandable why many investors may decide to continue overweighting their portfolios to what has worked in the past – though there’s no guarantee that will continue in the future.
Earnings growth estimates for the S&P 500 and S&P growth stocks for next year are 8% and 9%, respectively (see Figure 3), a return to their pre-Covid trends, and a downshift from their pandemic growth pace.
The fact that the earnings expectations have been lowered to their historical trend indicates to us that there may be a higher probability of a positive surprise. That’s a better situation, in our view, than overly optimistic expectations.
We believe it’s reasonable for portfolios with global equity allocations to tilt towards large-cap and large-cap growth stocks, given this analysis of valuations and earnings. That said, we also think that amid today’s many macro uncertainties, maintaining a balanced global equity exposure is a prudent way to prepare for another unprecedented year.

The commentary in this report is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here are not investment recommendations, but rather opinions that reflect the judgment of Horizon as of the date of the report and are subject to change without notice. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward looking statements cannot be guaranteed. 

We do not intend and will not endeavor to provide notice if and when our opinions or actions change. Horizon Investments is not soliciting any action based on this document. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. 

Index information is intended to be indicative of broad market conditions. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in any index. 

The S&P 500 or Standard & Poor’s 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. 

The MSCI-ACWI ex USA Index captures large and mid cap representation across 22 of 23 developed markets countries (excluding the U.S.) and 23 emerging markets countries. 

The S&P 500 Value Index measures the performance of the large-capitalization value sector in the U.S. equity market. It is a subset of the S&P 500 Index and consists of those stocks in the S&P 500 Index exhibiting the strongest value characteristics. 

The S&P 500 Growth Index measures the performance of the large-capitalization U.S. equities that exhibit growth characteristics. It is a subset of the S&P 500 Index.

© 2021 Horizon Investments, LLC.
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