It’s been a good year for the S&P 500, which as of Dec. 13, was up almost 25% year to date. This index of 500 major companies on the U.S. stock market is generally considered the best indicator of the overall market’s performance.
And 2021 has been a better than average year for the benchmark. Since the index’s inception in 1957, the long-term average has been about a 10% annual return. And in the past decade, only two years have outperformed the S&P 500’s year-to-date return: 2013 (up 29.6%) and 2019 (up 28.9%).
Given this strong showing, investors may be wondering what lies ahead for the S&P 500. While investors should always be thinking long term, it’s good to know where the market stands and have a sense of what to expect. It’s never too late to buy when you’re a long-term investor, but let’s take a look at where the S&P 500 might be heading.
Two major themes for 2022
As we head into 2022, there are some key themes to watch, starting with inflation. The Consumer Price Index jumped 6.8% in November, the highest increase in 39 years. That is the ninth straight month it has stayed above the Federal Reserve’s target of 2% inflation. The Fed expects inflation to fall around 2.2% in 2022, which is also above the target but significantly less than the anticipated 4.2% for 2021.
The higher-than-normal inflation forecast has prompted the Fed to consider raising interest rates earlier than anticipated, likely in 2022. Rates are near 0% right now, so bumping them up is a way to bring down inflation.
This would have an impact on the stock market but not across the board. Certain sectors like financials, energy, real estate, utilities, and healthcare tend to do well in inflationary environments, while technology, consumer goods, and consumer discretionary, among others, don’t do as well.
The other big factors in 2022 are the infrastructure bill and pending Build Back Better Act, which could invest almost $3 trillion into the economy over an extended period. An analysis by Moody’s Analytics said concerns these initiatives will lead to “undesirably high inflation and an overheating economy are overdone.” Longer term, many economists say the investments will increase productivity and growth, which will reduce inflation.
As for the impact on the markets, the massive investment will certainly benefit wide swaths of the economy, including transportation, construction, IT infrastructure, energy, manufacturing, and others — but don’t expect to see the investments start to kick in until the second half of 2022 and beyond.
Where is the S&P 500 headed?
So, what does this all mean for the S&P 500 next year? Analysts generally expect returns that are closer to historical averages. Companies in the S&P 500 posted record profits in the third quarter, and earnings growth in the index is expected to be 49.3% for 2021. But this is a bit of an anomaly, as the year featured a strong rebound from the pandemic. The average price-to-earnings ratio on the S&P 500 is about 28, which is well above where it has been over the past decade.
Analysts project much slower, more normalized earnings growth in 2022. Even so, LPL analysts Jeff Buchbinder and Ryan Detrick believe the “S&P 500 could be fairly valued at 5,000 to 5,100 at the end of 2022.” That would be about a 7% increase over current levels.
Goldman Sachs is in the same ballpark, projecting the S&P 500 will hit 5,100 by the end of next year. “Decelerating economic growth, a tightening Fed, and rising real yields suggest investors should expect modestly below-average returns next year,” analyst David Kostin said, according to U.S. News and World Report.
Certainly, the pandemic or some new variant that leads to shutdowns would throw these projections through a loop, but with vaccination rates slowly increasing, that’s not expected.
So as a long-term investor, you want to be in the market, even if we don’t see the type of returns enjoyed over the past year, because the cost of being out of the market is too high.
As Morgan Stanley CIO Lisa Shalett wrote, 2022 will be a “critical year in which the imbalances wrought by the pandemic will likely begin to resolve and the business cycle normalizes.” Driven by longer-term trends of innovation, deglobalization, decarbonization, and the transformation of the labor force, “investors need to be positioned not for a dearth of economic growth but an abundance of it.”
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