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Perish the thought – stock markets might fall

Mike Dolan
Mike Dolan
Reuters Editor-at-Large for Finance & Markets

Mike Dolan, editor-at-large for finance and markets at Reuters News, warns that everything may not be plain sailing for the stock markets in 2022. He analyses why headwinds such as inflation, a resurgent pandemic and geopolitics could derail momentum in equities. 

  1. Bank of America’s penultimate survey of fund managers in 2021 highlighted the largest instance of over-exposure to U.S equities in eight years, while weekly JPMorgan client surveys show that 60 percent of managers are planning to add even more equity exposure.
  2. The argument in support of equities is based on the sentiment that equity indices proved resistant to economic downturn during a global pandemic.
  3. However, Morgan Stanley forecasts a 6 percent decline against current levels in 2022 as policy supports are gradually removed in post-pandemic recovery.

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The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own

LONDON, Nov 17 (Reuters) – You almost have to re-read the small print for a reminder that stocks may ever fall again.

The oft-used compliance disclaimer that the value of your investments may go down as well as up seems to be largely ignored by stock investors these days.

And after a three-year winning streak, fund managers are clearly betting on another.

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High stock market exposure levels

Bank of America’s penultimate monthly fund manager survey of 2021 shows the biggest overweight U.S. equities in eight years – with as few as 8 percent of the 388 respondents, managing more than $1 trillion in assets, claiming to be underweight stocks at large.

And a weekly JPMorgan client survey had 60 percent planning to add even more equity exposure over the coming days and weeks.

Watch: Is a Stock Market Melt-Up on the Cards? | The Big Conversation | Refinitiv

As 2022 investment outlooks from banks and funds stream in, the basic arguments for sticking with stocks are pretty simple.

If a global pandemic and the sharpest economic contraction in a generation didn’t spark a negative year for expensive equity indices – many wonder just what will right now.

Keep riding the liquidity swell until it’s finally drained still seems to be the consensus.

Central banks may already be cutting emergency supports with inflation back on the radar, but the last place you want to be is in bonds unless you think we’re heading back into a slump within 12 months.

Few do.

It’s also hard to argue with the fact that stocks don’t often go down over a full calendar year anyhow. The S&P 500 has only ended in the red about one in four years since 1960.

What does the MSCI All-Country Stock Index indicate?

For a more diversified spread of equity risk, such as MSCI’s All-Country Stock Index, it’s been the best rolling three-year period since the bubble 20 years ago, and there have been only 4 down years since then.

The index has precisely doubled from the deep but brief pandemic trough of March 2020.

Aside from the famous boom and bust at the turn of the millennium, no three-year period has been better for stocks in the 34-year history of that global index.

34 years of MSCI's all-country index. Perish the thought – stock markets might fall

Given those metrics, the overwhelming consensus and the apparent lack of alternatives, you’re inclined to sit up and take notice when what was one of the most bullish houses on Wall St forecasts a drop in stocks in 2022.

S&P 500 to decline in 2022?

Just this week Morgan Stanley – one of the most vocal and accurate Wall St forecasters of a V-shaped market recovery after the pandemic hit last year – said it sees the S&P 500 some 6 percent below current levels by the end of next year.

That’s hardly a signal to run for the hills, but any negative sign on stock market forecasts is noteworthy these days and only the banking collapse of 2008 generated a more negative year for the S&P 500 since the crash.

Global market asset performance. Perish the thought – stock markets might fall

Removing the stabilisers

Morgan Stanley’s reasoning was far from alarmist, preferring to stress a “normalising” of growth and asset prices.

It talked of the “training wheels” coming off the post-COVID-19 recovery next year as policy supports are gradually removed and financial assets to have to balance on their own for a change.

“Markets are facing many ‘normal’ mid-cycle problems: better growth colliding with higher inflation, shifting policy and more expensive valuations.”

Keeping its call in the context of nerves about tighter credit and financial conditions, it sees 10-year Treasury yields ending 2022 back at 2.10 percent from 1.6 percent today – basically, only back to where it was in the middle of 2019.

Yet even these relatively anodyne forecasts are outliers.

Will widespread uncertainty rattle stock markets?

Goldman Sachs expects another 9 percent on the S&P 500 through next year, JPMorgan sees the index adding another 6 percent through the middle of next year at least and UBS sees it 6 percent higher by the end of 2022.

Of course, some of this is just about timing; just when does the wind change on policy mixed with still largely unknowable macro variables around inflation and even the pandemic itself.

Unigestion portfolio manager Olivier Marciot said he’s cautious about the year ahead but retains exposure to risk assets while watching central bank policy unfold.

“History has demonstrated that trying to anticipate the actual change in financial conditions from an accommodative to a tightening situation usually yields disappointing results.”

What’s more, forecasts already on the table are from where we stand in November. And a lot can happen in illiquid year-end markets when investors may be itching to bank profits.

Already the dollar is rising sharply on a mix of inflation and interest rate concerns but also on jarring geopolitics between Western allies and Russia and China – from the Belarus border to Ukraine and Taiwan and even in space. And a rising dollar effectively tightens world financial conditions on its own.

Military flashpoints or related energy price shocks and power blackouts in Europe and elsewhere could make for an even nervier year-end than usual.

Come New Year’s Eve, maybe even Morgan Stanley’s 2022 call will start to look bullish.

Investors most OW US equities since 2013. Perish the thought – stock markets might fall

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What's the outlook for markets in 2022?

Inflation, a resurgent pandemic and geopolitics could all derail momentum in equities.