By:Anna-Louise Jackson, Benjamin Curry

https://www.forbes.com/advisor/investing/2022-stock-market-outlook/

At just 21 months old, the bull market that began in March 2020 has already seen a gain of more than 114% in the S&P 500. This means it’s already outperformed the 2002 to 2007 rally, which lasted nearly four times as long.

After a year like 2021, when the S&P 500 rose in excess of 27%, it might be tempting to assume the trend will simply continue in 2022. But making predictions about the stock market is always a tricky endeavor, and 2022 is no exception.

“There are so many unique uncertainties right now, including the virus that, sadly two years later, we don’t have in the rearview mirror,” says Liz Ann Sonders, managing director and chief investment strategist at Charles Schwab.

There may also be a sense of deja vu as the U.S. grapples with a rising number of Covid-19 cases and deaths. Unlike last year, the economy is on more solid footing. Federal Reserve policymakers feel confident enough to signal plans to raise interest rates and end the Fed’s quantitative easing (QE) program, shifting its focus to dealing with inflation.

Investors can expect the Fed to be one of the “dominant forces” influencing the market’s trajectory in 2022, says Sonders. But the central bank’s policy shifts must be viewed in the context of broader market sentiment—and a change in sentiment remains the biggest risk to the market, she adds.

Even though the S&P 500 is poised to finish 2021 near (or potentially at) an all-time high, individual stocks haven’t fared so well—and 93% of the index’s constituents experienced a selloff in excess of 10% in 2021. “This notion of resilience on the part of the market is only at the index level,” Sonders says. “There are pockets of significant weakness.”

The biggest question heading into 2022 is whether some catalyst—be it pandemic-related, a slowdown in economic growth, the Fed’s shifting policy, or something else—will finally drive a bigger selloff in the stock market than occurred in 2021. Here’s what to watch for in 2022.

Analysts See Subdued Market Gains in 2022 and More Volatility

Wall Street strategists have been trying to make sense of what 2022 has in store, and their forecasts are pretty wide-ranging.

On the low end, Morgan Stanley has a year-end 2022 target for the S&P 500 of 4,400, which would amount to a decline of almost 9% from current levels. Conversely, Wells Fargo forecasts that the index could hit 5,300, delivering another year of strong gains.

Analysts who cover individual stocks have a similarly optimistic outlook. When their 2022 price targets for all companies in the S&P 500 are factored together, they see the index closing out 2022 at 5,225, according to data compiled by FactSet.

U.S. Bank’s S&P 500 forecast sees the index reaching 5,060 in 2022, reflecting a “glass half full” outlook based on still-strong corporate sales and profit growth, measured inflation and low interest rates, says Terry Sandven, U.S. Bank’s chief equity strategist. These factors suggest a favorable backdrop for stocks, with the potential for “more subdued” gains of about 8% from mid-December levels, he adds.

Like Sonders, Sandven says that forecasting for 2022 is more challenging than past years—particularly after such a strong year of performance. “To a degree, the market is priced to perfection with a narrow margin of error,” he says.

Given that backdrop, investors can expect more speculation about a market correction in the year ahead. The S&P 500 hasn’t seen a proper correction since the bear market in early 2020. A decline of 10% to 20% has occurred about once every 19 months, on average, going back to 1928.

To wit, the recent bout of volatility could also continue, Sandven says. In late November, the S&P 500 snapped a 29-day stretch when it failed to move up or down by more than 1% and then notched nine such moves over a 15-day run.

While Charles Schwab doesn’t forecast a 2022 price target for the S&P 500, Sonders sees potential for a “good” year, albeit with a decent risk of weakness as market participants account for Fed policy changes. Market volatility could be front-loaded in the year, offering a better base for the market to improve on in the latter half of the year, she adds.

Fed Policy, Inflation and Taxes in 2022

Market forecasts for 2022 ultimately come down to predicting the continued impact of the Covid-19 pandemic, particularly given the late 2021 spike in cases and uncertainty caused by the new omicron variant. It has the potential to cause further supply chain disruptions, impact global demand and exacerbate inflation.

“The path of the economy continues to depend on the course of the virus,” read the Federal Open Market Committee’s (FOMC) statement following the December Fed meeting. Policymakers accelerated the tapering of its bond-buying program, citing inflation that’s exceeded its 2% target now for “some time.”

The pace at which the Fed raises interest rates will be key, says Sonders while the number of rate hikes matters less than the broader policy change. “Our belief is that the overall economy warrants something other than distress-level interest rates,” says Sandven.

Investors will also be focusing on the potential tax changes in the Build Back Better Act, which target wealthy individuals and corporations. Because corporate earnings are one key to the market’s performance, any change in corporate tax rates has the potential to alter the outlook for earnings, says Sandven.

Making Sense of a Market of Stocks

Even with some churn under the surface of the S&P 500, 2021 is ending with all 11 market sectors up for the year. “The performance report card for 2021 is essentially superb and indicative of an economy that still has some strength,” says Sandven.

What does that mean for investors heading into 2022? Tech, the largest sector in the S&P 500, will remain vital. It’s among U.S. Bank’s top picks, along with consumer discretionary and health care stocks, Sandven says. Meanwhile, Charles Schwab is recommending investors focus on quality stocks and avoid trying to time any sector rotation in their portfolios, Sonders adds.

The year ahead could also see small-cap and mid-cap stocks do some catching up, after lagging behind their large-cap counterparts in 2021. The small- and mid-cap focused Russell 2000 is poised to post gains of nearly 14% this year, about half the gain seen in the S&P 500. “We would look for that gap to narrow somewhat,” Sandven says. “We like the outlook for many of these companies in the new year.”

Even so, much of 2022’s potential performance depends on all the things no one can accurately predict right now. Inflation is key to any change in Sandven’s “glass half full” outlook—specifically, how sustainable current trends are and whether inflation proves to be a nonevent or is running hot, he says.

“By mid-year, we should know what the level of inflation is, and that will set the tone for the second half of the year,” he says.