SoFi’s head of investment strategy sees rising rates as one of the hurdles facing stocks in 2022.
Liz Young is head of investment strategy for personal finance firm SoFi.
What’s ahead for stocks in 2022? I would say that in 2022, we’re going to be transitioning back to a more normal market. Normal price returns on the S&P 500 are in the 7% to 9% range (slightly higher with dividends reinvested). The reason I wouldn’t get off-the-charts bullish is that we’re entering an environment in which artificial liquidity is starting to dry up. The Federal Reserve is taking its foot off the pedal slightly. If market expectations are correct, the Fed’s program of tapering its bond purchases, which were put in place to stimulate the economy, will finish around June of 2022. I actually think they may taper a little more quickly than that. Later in 2022, we could see our first rate hike of this expansion. Those are two things that the markets will have to trudge through.
How might that play out? We’re expecting long-term rates to gradually grind higher. That means the largest sector in the S&P 500—technology—will probably face pressure, and the other 10 sectors will have to work extra hard in order to get us up to a healthy return.
Why the pressure on tech stocks? When you buy growth stocks today—think of technology and communications services—you’re saying you believe these stocks have the opportunity to experience strong long-term growth. But as the long end, or 10-year portion, of the yield curve rises—which it usually does in inflationary environments and when you expect the Fed to raise interest rates—profits that are largely future-loaded become less valuable in the present.
So, would you avoid tech now? That becomes a real time-horizon question. When you look at the next six months, tech stocks might see some pressure as rates rise. But when you think about it from a longer-term perspective, there’s still plenty of opportunity in technology. There’s a labor shortage across the U.S. Companies will have to invest in technology to stay efficient and productive and to meet demand. So, technology continues to be a necessity as we build a more efficient labor force and as we deal with a shrinking labor force, which is happening because of demographics as well as some pandemic-related factors.
Also, we just went through a health care crisis that I would argue we weren’t prepared for. To boost preparedness for some sort of disaster like this in the future, I think the marriage between health care and technology will pick up exponentially, further driving investment in technology. Long term, for the American economy, tech is a good play.
Where do you see opportunities for investors in 2022? If the yield curve steepens and longer-term rates go up, we’d hope it’s happening because the economy is expanding—we’re producing more goods and consumers are spending. In that environment, you should see some reopening names do well again. Leisure and hospitality stocks should see another nice bounce-back as travel restrictions continue to loosen. We’re thinking about hotels, casinos, airlines—which fall under industrials, but you can think about them as part of the travel industry in general. Financials continue to be a favorite of mine. They had a really nice third-quarter earnings season, and they’re poised to do well as the economy continues to recover.
I also like small-cap stocks for 2022. They do well in inflationary environments and in economic expansions. Small caps lagged for much of 2021, which makes them look less frothy than some of their large-cap counterparts. As far as style from a growth or value perspective, as rates begin to rise globally—a number of central banks are ahead of the Fed on that narrative—that’s generally a headwind for growth companies. And in turn, it’s a tailwind for value-oriented sectors.
Are stocks too pricey now? Forward price-earnings ratios, based on estimated earnings, have come down, but the market is at all-time highs. That’s possible because the E, earnings, have come back, and prices haven’t risen as fast. That’s a healthy reason to see a decrease in the price-earnings ratio compared to the earlier part of this recovery, when the increase in valuations was caused by the P rising faster than the E. Looking ahead, the speed of earnings growth is naturally going to slow because it’s not bouncing off a bottom anymore —and that’s okay. What you don’t want to see is earnings hit by a contraction or slowdown in the economy, or by the increase in inflation. That’s something I’d be listening for—what’s the stamina of companies to absorb higher input costs, and what’s the stamina of consumers to pay higher costs?
What’s the biggest risk facing the market now? The risk is that we’re in the seventh month of inflation above 4%, the sixth month above 5%. That can cause consternation in the market, largely due to the expectation that the Fed will raise rates, and the markets typically don’t like a rate hike. Supply-chain issues have not abated, and neither has demand. That tells me inflation will stay high for a while. We came into the pandemic with an inflation rate of just over 2%. I would expect it to stay well above that, say 2.5% to 3%. I’d even go as high as 3.5% for a while. It’s a risk because it’s going to hit the consumer pocketbook. If that happens coupled with a slowdown in economic growth, well, that’s where all this stagflation talk comes from.
Do you see a market correction in the offing? There could always be a correction coming. We haven’t had much of one in 2021. We were down about 5%, max—that’s much smaller than what we usually see. We’re due, as far as the calendar goes, but it doesn’t necessarily have to happen. Another risk in the market is that the Fed is still in emergency mode. We need to get off 0% interest rates, get some of this artificial liquidity to stop flowing into the system so we have the tools to fight it if another market or economic challenge should present itself.