2022 will 'have a high wall of worry that we’re going to have to scale,' market strategist says

CFRA Chief Investment Strategist Sam Stovall joins Yahoo Finance Live to discuss his 2022 stock market outlook after a big 2021.

Video Transcript

ZACK GUZMAN: As we said, a down day to wrap up the year, but overall, the strongest year for returns since 2019, at least when you look at the S&P 500 there. And for more on what 2022 could hold, let's bring in Sam Stovall, CFRA chief investment strategist, here to wrap up 2021. Appreciate you coming on here to chat with us, Sam.

I mean, when we're looking at it, the story, I guess-- the stories are laid out for what 2022 will hold when it comes to the Fed hiking an expected three times. When you look at maybe some of the biggest stories in 2021, though, inflation likely to carry over as well. What are you seeing maybe shape up for the year of investing in 2022?

SAM STOVALL: Well, first off, early happy New Year to you. I think that 2022 is going to be a good year that tends to follow a great year. We certainly have a high wall of worry that we're going to have to scale-- as you mentioned, in terms of inflation concerns, what the Fed will be doing with interest rates, et cetera.

It is the second year of a president's term in office, the sophomore slump, and volatility tends to be 40% higher in that second year as compared with the other three years. And if the Fed does indeed start to raise short-term rates and longer-term rates tend to follow, well, then we could see a contraction in P/E multiples since we have a negative 0.5 correlation between the 10-year yield and S&P 500 P/E ratios.

BRIAN CHEUNG: Hey, Sam, Brian Cheung here. So I feel like one factor that was kind of thematic through 2021 was margins, especially with rising inflation. It seemed like a lot of companies had no issue still being able to preserve their margins despite these higher input costs. Now as the Fed tightens next year, might that change things? And I know that's only maybe tangentially related to what you were talking about with P/E, but when it comes to the big story for 2022, that seems like that could be a real big difference in the operating environment.

SAM STOVALL: Sure, it could be. Certainly for those, you know, older, more value-oriented companies that do have higher interest expense, we could see some margin reduction along with increase in input costs, commodity costs, et cetera.

Wall Street is not really making a big bet that way, however. S&P Capital IQ is still pointing to about mid 13% margin for the S&P 500, actually slightly higher than what is anticipated for 2021. So maybe that's a lagging indicator based on consensus estimates, but it looks as if profit margins are likely to remain fairly healthy.

ZACK GUZMAN: Yeah, we still do have a couple, I guess, headwinds there when you think about decelerating earnings per share growth. You've got, as you said, the sophomore slump for President Biden, a few different things.

I mean, when you're looking at maybe where investors should be hiding out, maybe playing defensive next year, what is kind of maybe, I guess, the takeaways for best practices-- really be reshaping-- reallocating heading into the new year?

SAM STOVALL: Well, I guess the first question is if you think that we are heading into a 1970s kind of inflationary environment-- which I don't-- then you want to be leveraging the inflation hedges like energy, like materials, and you want to be staying away from the growth areas like consumer discretionary and technology.

In a little shorter term, however, what we find is that in this most recent month, December, while utilities was the best-performing sector and tech was among the worst performers, that's actually not out of the ordinary. December normally sees utilities as the best performer, tech as the worst performer. But what December gives, January takes away, and, on average, tech ends up being the best performer in January by a 3 to 1 margin as compared with the second-best sector, and utilities tend to decline in January.

So near term, short term, I still think that we're in the seasonal sweet spot for the market where the cyclical and growth areas do well, at least until that sell in May period.

BRIAN CHEUNG: Sam, what do you see as the outlook on volatility broadly? Because what was interesting was that thematically, also in 2021 we did see volatility decrease. Maybe the vaccine helped that, although the omicron variant did reintroduce some of that volatility in November.

Now with the Fed also becoming an uncertainty in 2023 and possible new variants remaining a possible issue, do you see volatility as maybe only going to the upside next year, or do you think things might stay relatively calm?

SAM STOVALL: No, I think that volatility is likely to increase and probably increase fairly dramatically. In 2021, it was basically an average year. The number of days in which the market was up or down by 1% was 55 versus the average of 51 since World War II. Also, the difference between the closing high and the closing low for the S&P 500 was 27 percentage points, which is essentially equal to the average since World War II.

So I think that, you know, when you come to volatility, an average year usually breaks out of that average mold in the coming year and sophomore slumps because the second and third quarter are traditionally down in terms of price for the S&P 500. And then we see among the two strongest quarters in the final quarter of next year. That could certainly add to the overall volatility.

BRIAN CHEUNG: Yeah, well, I mean, still the ups and downs this year did bring us 70 days of all-time highs on the S&P 500, only eclipsed by 1995. We'll see if 2022 has more to bring.

Sam Stovall, CFRA chief investment strategist, happy New Year to you.

SAM STOVALL: Happy New Year.