Outlook 2022: New day dawning for the markets

“2022 COULD BE A PIVOTAL YEAR for the economy, the markets and investors,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. As the world and financial markets continue to navigate the impact of the pandemic, Hyzy believes key forces are in place to drive a new level of growth. Looking ahead, he sees what he calls “a great new dawn,” characterized by advancing innovation, vigorous capital spending and structural changes that will serve as a catalyst for the next business cycle.

Investors, who collectively are sitting on cash reserves of $4.6 trillion in money market funds¹, are well positioned to take advantage of above-average economic growth and a stock market that could continue its advance, helped by strong corporate profits. Yet the year ahead may also bring volatility amid uncertainty about the impact of the latest coronavirus variant, higher inflation, the potential for rising interest rates, proposed tax reform and concerns about China and other parts of the global landscape.

Below, Hyzy; Joseph Curtin, head of Portfolio Management in the Chief Investment Office, Merrill and Bank of America Private Bank; Marci McGregor, senior investment strategist, Chief Investment Office, Merrill and Bank of America Private Bank; and Joseph Quinlan, head of CIO Market Strategy in the Chief Investment Office, Merrill and Bank of America Private Bank, discuss what they believe will be the key drivers of — and risks to — growth in 2022, and share ideas for how you can prepare for both. For more on the CIO’s outlook for the year ahead, read The Great New Dawn. And watch our year-ahead webcast, “Outlook 2022: The Dawn of a Breakout Era?”

An orderly “pivot” to control inflation

In what may be the strongest sign that the new dawn has begun, the Federal Reserve (the Fed) has begun moving away from the extraordinary measures it took to help spur the economy and slow job losses during the pandemic. In November 2021, it started tapering its bond purchases, “from $120 billion a month all the way down to zero,” according to a schedule that would originally end tapering by June, says Hyzy, who notes that this change is possible and necessary because of robust economic growth.

The Fed could follow up with two interest rate hikes before the end of 2022, he adds. But if inflation remains stubbornly high, that timetable could be accelerated, with an end to tapering by March and perhaps three rate hikes by year’s end. “It’s going to be hard for inflation to come down as fast as everybody wants until the Fed begins to accelerate the removal of its emergency measures,” Hyzy says.

What this could mean for your portfolio: The impact of the Fed’s pullback could be felt throughout the markets, notes Curtin, but for many investors it might serve as a signal to shift from equity portfolios with relatively narrow concentrations in large technology growth stocks to more broadly diversified, economically sensitive holdings. One way to do that is by increasing your small-cap and value stock holdings. And because interest rates are likely to rise, investors might want to limit their exposure to long-term fixed income holdings, which would decline in value as a result.

Companies with cash to invest

Years of steadily growing corporate earnings have left corporations with strong balance sheets, says McGregor, and now the question is how they’ll deploy the trillions of dollars of cash on their books. Some of that money will fuel “an entirely new cycle of capital investment,” believes Hyzy, as companies invest in innovation across a wide range of areas. “With labor a huge issue for both large and small businesses, they’re going to have to invest in automation and efficiency,” adds McGregor. “We also have a healthy backdrop now for companies to raise their dividends.”

What this could mean for your portfolio: “With bond yields still low and growth in equity markets likely to moderate, stocks that pay dividends can serve as a portfolio hedge,” McGregor says. Focusing on dividend growth from high-quality companies with a long history of increasing payouts may be preferable to looking for stocks with the highest current dividends, she adds.

The far-reaching impact of the infrastructure bill

The $1 trillion Infrastructure Investment and Jobs Act, signed into law in November 2021, includes $550 billion in funding for America’s aging highways, roads, bridges and tunnels, as well as upgrades to the nation’s power grid and greater access to broadband internet over the next 10 years. The length of that timeline means that the near-term impact on corporate profits will be minimal, according to Quinlan, but it may also boost future earnings in commodities, industrials and other sectors. “Infrastructure spending is America’s best chance to be globally competitive in terms of rail, airports and shipping ports,” he says.

What this could mean for your portfolio: Looking ahead, Quinlan sees huge opportunities for 5G cellular technology and fiber optics as broadband internet is extended to rural and other underserved communities. He also suggests considering material and industrial leaders that make pumps, valves, waste management treatment and cellular equipment, as well as producers of copper, iron, steel and other commodities.

Supply chain and other national security issues

Driven in part by high demand as the new dawn unfolds, persistent problems with supply chains have snarled ports and put pressure on prices, adding urgency to ongoing efforts by companies to seek suppliers closer to home, says McGregor. “During the pandemic, supply chains for pharmaceuticals and medical devices and equipment — crucial in battling the pandemic — have gotten much of the focus,” she says. “But having strong, secure supply chains in other areas, too, is critical to our economy and national security — not in terms of national defense so much as in delivering important parts and products needed to keep the economy running.” Also crucial is cyber security for both the private and public sectors, she says.

What this could mean for your portfolio: McGregor believes sectors including health care and cyber security, as well as robotics, artificial intelligence and other areas needed for increased automation that will help offset labor shortages, are likely to benefit from increasing demand and could offer potential long-term opportunities. But don’t forget about large technology companies that are also essential to national security and continue to innovate. Earnings projections for semiconductor companies, in particular, remain strong, she says.

Sustainable practices to help save the planet

Pandemic shutdowns had a profound impact on the environment, Quinlan notes, improving air and water quality and showing just how much damage everyday modern life does to the planet. “That lesson continues to resonate with policy makers, corporations and consumers,” he says. Now, as the economy’s new dawn begins and strengthens, the Earth remains front and center, and the “circular economy,” in which products are recycled and reused multiple times, will become an increasing priority.

What this could mean for your portfolio: Investing in companies with strong environmental, social and governance (ESG) records could help align portfolios with these themes. One approach Quinlan suggests is to look for innovative small companies with a focus on solving environmental problems. In addition, companies that prioritize social issues, such as the health and welfare of their workforce and community, could be an important consideration.

China and the international economy

Going into 2022, the economies of Europe and much of Asia have accelerated their expansion, a trend that Quinlan believes could lead to strong domestic consumption in these countries and potentially boost the earnings of multinational U.S. companies. At the same time, growth in China is expected to moderate and tensions between the United States and China could continue. Any positive signals between the two countries — for example, a reduction in tariffs — might help alleviate concerns.

What this could mean for your portfolio: Uncertainty about the overall outlook for global growth, as well as the continued strength of the U.S. dollar, are among the reasons that Hyzy and others in the CIO continue to favor U.S. equities over international stocks. Still, a global economic expansion is continuing, and the growth in earnings of many international companies is beginning to match or exceed domestic companies’ profit gains. When you do choose to invest globally, Quinlan suggests being highly selective. While he sees the potential for overall growth internationally, he suggests focusing on what certain countries do best — for instance, France and fashion and luxury goods; Japan and robotics and electronics; renewables in the Nordic countries.

Steps you can consider taking now to prepare

Overall, says Hyzy, the year ahead for investors is likely to involve increased market volatility as changes in the economy and the markets continue to work themselves out. Hyzy suggests that investors increase their level of diversification, both within and across asset classes, and also “emphasize dividend growth and balance cyclical stocks with those that build on stable growth in long-term investments.” Qualified investors could also consider opportunities in alternative investments, which could add another layer of diversification to a portfolio.

The start of a new year can provide a good opportunity to speak to your advisor about any potential changes you might want to make to your portfolio, says Curtin. For example, “just about every industry is being affected by disruptive innovation,” he notes. “So as a complement to your broad investments, consider investing in areas affected by that disruption, in order to potentially take advantage of those themes.”

During your conversation with your advisor, Curtin suggests you revisit your financial goals and priorities and consider whether any changes in your life situation or comfort with risk could call for an adjustment to your investment strategy. “This is the time to ask questions,” Curtin says.