Will the stock market (S&P 500) be higher in 90 days (Jan 2022)?

My fearless forecast

Yes

Prediction Date: 01/12/2022

Deadline Date: 04/12/2022

Jan 28 Update: This has been a rough forecast, with markets continuing to see extreme volatility to begin the year and economists calling for as many as seven rate hikes in 2022 – which will no doubt cause continued market turmoil. I continue to keep this forecast open as I am optimistic about the US economy, but there is a long slog ahead with the S&P 500 down 6% since my call.

Original Prediction

Today, Jan 12, the stock market, as defined by the S&P 500, closed at 4726.35, just down slightly to begin the new year. Despite wild swings and a pandemic, the S&P 500 has had three banner years in a row, up 29% in 2019, 16% in 2020 and 27% in 2021.

Based on all conventional valuation measures (backwards looking P/E, forward looking P/E, expected returns relative to economic growth, etc…), the US stock market seems to be overdue for a correction.

S&P 500 Index over the last 12 months
Source: TradingView

Triggers for a correction are lining up, incl. the end of the Fed’s QE4 stimulus program, high inflation (7% for 2021), continued supply chain issues, omicron wreaking havoc on staffing and health, 3-4 Fed hikes this year and even geopolitical noise in China and Russia.

FOMC projections for policy rate at end of calendar year (i.e. 3 rate hikes in 2022)
Source: Federal Reserve

Perhaps most worryingly, interest rates have begun spiking in the few weeks, perhaps reflecting a combination of fears around inflation, hot economic growth prospects as Covid recedes or continued Fed interest rate hikes. While interest rates did spike in January 2021 in anticipation of vaccines becoming wildly available, they ended up receding through much of 2021.

Entering 2022, interest rates have continued to spike, and indeed, interest rates have spiked to levels that have exceeded levels seen in all of 2020, officially putting us back on pre-Covid footing (updated Jan 18). High interest rates can be problematic as it does have a very real impact on the economy, essentially serving as a brake on the credit transmission channel for individual and corporate borrowers, and also leading to a portfolio rebalancing away from the riskiest parts of the market (e.g. meme stocks and crypto to generic equities, and generic equities back to fixed income).

10 year treasury yields over the last 5 years
Source: TradingView

However, despite all the turbulence, the economy is still strong with unemployment low and consumption continuing to drive the economy. Business investment, US innovation, government stimulus and a robust real estate market should continue to power the stock market through the noise. While high interest rates can lead to an economic downturn, the experience of the 2013 taper tantrum and the messaging seen in 2019 shows that the Fed pay an overwhelming amount of attention to the stock market, and would hesitate to overcorrect, particularly in the face of trying to ensure that the economy stays hot so that the wealth effects truly ripple out to the poorest and most disadvantaged communities.

Indeed, it is my perspective that high interest rates signify investor confidence in a boom economy, a modest escape from the “secular stagnation thesis” seen in the mid 2010s and a true exit from Covid related induced disruptions in 2022.

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