Although the Australian and Global Market (ex-US) have served up very respectable double-digit equity returns over the past decade since 2012, the world’s largest economy is in a league of its own returning over 20% annualised over 10 years. Technology has emerged as a star sector along with consumer cyclicals on the back of large advances from mega caps such as Tesla, NVIDIA, Apple and Amazon.

But US markets have been on a bumpy ride in 2023 so far. The most princely corners of the markets absorbed the heaviest blows. The US Market Index dropped 2.4% over the first 10 days of 2022, but the US Technology Index tumbled 5.3%. At the same time, value stocks and sectors like energy and financials surged.

Nineteen percent of the stocks in the technology and communication services index have now corrected more than 50% from 52-week highs.

Chief markets editor, Tom Lauricella, gave us a few clues this week about the rationale behind the volatility. He maintains this all comes back to the interaction between the financial markets, the Federal Reserve and the economy.

Remember all that stuff you heard last year about inflation team transitory vs. team permanent? Forecasters were arguing over whether the $20 trillion of fiscal stimulus injected into the US economy during the covid-19 pandemic would end up yielding a more persistent string of price hikes at the grocery store, and the petrol pump. Today the verdict is in. Rising household costs are cutting into pay raises and increasing pressure on the Federal Reserve to counter this spreading threat to the US economy by hiking interest rates. At its December policy meeting, the Fed signaled a hard pivot to a much more accelerated pace of interest-rate hikes in 2022.

The stock market rally of 2021, especially for growth stocks, was based on easy money policies from the Fed and cash from fiscal stimulus programs, Lauricella says. But as government stimulus fades and interest rates are poised to rise, growth stocks have retreated and value stocks have gained. That’s because as inflation picks up speed and policymakers pump rates, the value of companies’ future earnings wanes, and investors have more other places to turn to to make money. This especially punishes technology stocks that deliver the prospect of growing future profits. Technology sector director Brian Colello puts it this way:

“We now live in a world that has higher interest rates, which means a higher discount rate, which means more likely that investors will value future earnings less than they would have in a very low interest rate environment.”

Lower growth expectations

So, is this still the place to be? While many analysts say conditions are favorable, they are predicting weaker equity returns in the context of a world of rising rates, uncertain growth and high valuations compared with the rip-roaring rallies of the last two years. A balancing act looms ahead for the policymakers of 2022: how to withdraw stimulus fast enough to tame inflation without slamming the brakes on an economic recovery that is already taking its foot off of the post-pandemic breakneck speed, Lewis Jackson wrote in a roundup of what equity market analysts are expecting for 2022.

Jason De Sena Trennert, the chief investment strategist at Strategas Securities, discussed this with Lauricella and says he expects 2022 to be a year when stock market returns will also be tougher to find. “You’re not going to be able to get 20%-plus just for showing up three years from now,” he says. He says the key to stronger performance will be smart stock-picking and accurate calls on performance among stock sectors. “It’s hard to get negative on stocks, but I do think people should be a little cautious about their expectations.”

Wall Street rakes in less than 4% on average annually, according to funds management titan Vanguard. While central banks are looking for a ‘Goldilocks scenario’ of sustaining growth while keeping inflation in check, a patchwork of challenges from supply chain snags to tight labour markets might still compel them to move more aggressively than markets expect, according to Joe David, Vanguard’s global chief economist.

It's not all bad news. The omicron variant will deliver, at the most, a “slight hit to economic growth,” according to a senior analyst, who nonetheless is now expecting inflation to be impacted as supply chain difficulties get “pushed to the extreme.” Longer-run, he sees too few reasons to believe that supply constraints will not eventually get worked out and thinks that inflation forecasters are reacting too strongly to short-term concerns.

Value in the unloved

As a whole, the US stock market is entering 2022 overvalued by 5% and some of its best performers are at particularly frothy prices. As it stands, only one corner of the market small-value stocks has a cheap look. But analysts still see opportunities in a variety of names across sectors. This week we collated two long lists of both US and home ideas to consider: 33 US stocks for 2022; 11 Aussie stock ideas for 2022.

In this week’s Your Money Weekly, Peter Warnes writes that the switch from growth style to value style stocks will continue this year, and that the income component rather than the capital component is likely to dominate total shareholder returns for the foreseeable future.

Strategas’s Trennert said his firm remains sticking with calls to overweight energy, basic materials and financials. “One of the points that we’ve made is that the [sustainable investing] movement is making energy stocks better investments,” Tyron Trennert, chief investment strategist at Strategas Research Partners, tells me. Broadly speaking, energy stocks are the most undervalued sector in the market, according to fair value estimates.

Colello, in the technology sector, sees opportunities in the sell-off but advises investors to look for high-quality businesses. “There are highflyers in our coverage universe that did extraordinarily well in 2020 and 2021, and in this pullback, some of those names are now cheap.” “You would probably want to be pointing investors toward wide economic moat, high-quality software names that have been beaten up as part of this sell-off.”

China’s regulatory crackdowns in 2021 on the technology and property sectors have been the biggest contributor to the steep underperformance of Chinese equities outside the US versus other emerging markets, and have led to elevated risk. State Street Global Advisors, however, points out that China’s equity market looks “structurally undervalued” and that even though the growth trend is in deceleration, its growth rate “will remain far above that of developed markets and slightly above that of other emerging markets.” They are also positive on European equities, which they felt were in a “sweet spot,” and said had “better growth prospects than the US market.”