Stock Market Outlook: What to Expect in 2022 - Your Money Briefing - WSJ Podcasts (2024)

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J.R. Whalen: Here's your Money Briefing for Wednesday, December 29th. I'm J.R. Whalen for The Wall Street Journal.The spread of the Omicron variant has given stock markets fits during the month of December, but stocks are still up quite a bit for the year overall. That's good news for your investment portfolio or 401(k), but many market analysts believe the gains we saw on Wall Street in 2021 are unlikely to continue in 2022.

Gregory Davis: If you go back and you look at the historical returns for the equity markets being in a 9% to 10% range and on a year-to-date basis, or if you look at the last year, we've seen a return of over 24%, it's very unlikely that you're going to see the same type of returns going into the future.

J.R. Whalen: Coming up, we'll talk with Gregory Davis, the Chief Investment Officer at Vanguard about the headwinds that are likely to impact markets next year, and what individual investors should do now to protect their assets. That's after the break.Stock markets continue to trend higher in 2021, but in the face of rising coronavirus infections and higher inflation, how will markets react in 2022? Let's bring in Gregory Davis. He's Chief Investment Officer at the investment management company, Vanguard. Greg, thanks so much for being with us.

Gregory Davis: It's a pleasure. Great to be here with you.

J.R. Whalen: So Greg, the pandemic and rising inflation were two factors injecting a lot of uncertainty into the economy this year. Now given that Wall Street doesn't like uncertainty, why did markets continue to trend higher for most of the year?

Gregory Davis: It's a great question, J.R. The primary reason is there's been an unprecedented amount of fiscal as well as monetary policy stimulus that's entered into the markets and into the economy. So the fact that the Federal Reserve has been so accommodative, the fact that they've ultimately reduced interest rates to zero, went through the whole process of quantitative easing, which they're now starting to scale back, as well as the tremendous amount of fiscal stimulus that actually came across from Congress, were two of the main drivers of why the market rebounded so quickly during the height of the pandemic. So again, the fact that you had the stimulus, you had easy monetary conditions. Those were all big catalysts to help return the equity markets and the broader markets to a very positive footing.

J.R. Whalen: Now, are the market gains we saw in 2021 likely to continue into next year?

Gregory Davis: We tend not to look at individual years when it comes to our forecast for equity market returns or bond market returns. The reality is that we saw this outsized return, and if you go back and you look at the historical returns for the equity markets being in a 9% to 10% range and on a year-to-date basis, or if you look at the last year, we've seen a return of over 24%, it's very unlikely that you're going to see the same type of returns going into the future.So what we try to always caution our investors is that take a very long-term focus when it comes to investing, make sure that you have the right risk profile in your portfolio. Because again, when we think about equity market returns over the next decade, we do expect them to be muted relative to history, just given the fact that we've had such outsized gains over the last 10 years or so. So investors really need to have more moderate expectations for equity market returns going forward.

J.R. Whalen: Specifically, what kind of headwinds do you see the market very likely to face in 2022?

Gregory Davis: There are a few headwinds. Number one, the Omicron variant is clearly causing some pause in the markets and how people function day to day. So that's one. The second one would really be the fact that the Federal Reserve has signaled their tightening monetary policy. So they're doubling the pace of their tapering of their balance sheet. So that's another headwind and it's very likely they're going to start raising interest rates at the tail end of the tapering, which we're going to expect to start seeing happening sometime in the March, April timeframe of 2022.So those are some of the headwinds. And the other one I would just say for listeners is the fact that valuations are still heavily stretched when it comes to equity markets, portions of the fixed income markets. So you're not getting paid to take a lot of risk at this point in time either. So there's a lot of headwinds out there.

J.R. Whalen: Now, the Fed signaled that it expects to increase interest rates as many as three times next year. It's a lot faster than officials projected just a couple of months ago. So how is that accelerated timeline luckily to affect markets over the course of next year?

Gregory Davis: It's a great question J.R. The markets have already taken that into stride, so I think most folks were coming into the year expecting the Fed's going to hike two times next year. And that's been basically increased if you looked at the Fed's dot plot indicating three times in 2022, and potentially three more times in 2023. But we all know that the Federal Reserve, these are projections based upon all the information and data that they have available today and when they were meeting.The reality is, it's going to be dependent upon how the economy continues to evolve over time, what they see when it comes to employment, what they see in terms of inflation. So again, it's a best estimate given where conditions are today, but it's going to be fluid. If the economy ends up growing at a slower pace, inflation ends up tapering a bit more quickly than what they're projecting. They could end up increasing interest rates at a much lower pace than what's priced in. But again, it depends on the data.Our own view is that they will hike rates three times based upon what we know today and what our forecasts are. The likelihood is that by the time this cycle is complete, they're probably going to get to a point where you could see the Fed fund rate approaching around 2.5% in the long run. But again, it's going to be driven by the data that we see for the economy, labor, as well as inflation.

J.R. Whalen: All right. So let's talk about particular kinds of investments. 2021 has been a record-breaking year for ETFs or exchange traded funds, which are essentially baskets of stocks. Why have investors been so interested in them in the past year and how have they lived up to expectations?

Gregory Davis: Well, there's a couple things. The fact that ETFs are offered in such a low cost manner, so I think a lot of investors have really been flocking to low-cost investing, because again, it's one of the things they can control. Investors have really recognized that to the extent they're paying higher fees. That's going to reduce their long-term returns. So that's why people have been gravitating towards ETFs.The other key component is they are somewhat tax efficient. So in many cases, ETFs because of their inflows and outflows, and the fact that they tend to be done with securities and in-kind mechanisms, they become a bit more tax efficient than many other mutual funds. So the tax efficiency, the lower cost, the ease of use and the ability that many folks can now trade ETFs for free, those are all primary considerations in terms of why ETFs have really seen a significant rise over time.

J.R. Whalen: Are there particular areas or sectors you expect to see significant growth next year?

Gregory Davis: We've seen a lot of investors over the last couple years gravitating more towards bond ETFs because it's so simple. You can go out and buy a bond ETF that gives you just tremendous diversification. We continue to expect to see success when it comes to the broad base equity ETFs as well, because it's a very simple solution. You just go out and you buy one ticker and you have access to thousands of securities by the press of a button. And again, because many brokerage firms allow ETFs to be traded for no commissions, it's just a very efficient way for folks to get exposure without having to pick individual securities.

J.R. Whalen: Now, earlier you mentioned being mindful of your risk portfolio going into next year to be ready for what the market might do. So I want to talk about individual investors for a moment. People with stock portfolios and 401(k)s. How can they prepare their accounts for the changes we could see in the market next year?

Gregory Davis: Well, I think there's a lot of need for investors to keep in mind the value of diversification. So making sure that you have a broadly diversified portfolio across not just stocks in the US, but across stocks in the international markets as well. Then also making sure they have the right mix in their portfolio of stocks, bonds, and cash. Because again, you have to be able to sleep well at night, and what you don't want investors to do is if you get to a point where you see an equity market correction, that they're actually panicking and doing something that would not be helpful to their long-term investment success.So we always try to think about and tell investors to make sure they have the right level risk in the portfolios, that they do sleep at night. And ultimately making sure that when there is a setback in the equity markets, to rebalance back into equity markets, if that waiting has dipped below their ideal target. So the importance of rebalance is not something to be understated.

J.R. Whalen: So maybe just stay the course?

Gregory Davis: That's correct. And again, what you can control is how much you're saving, how long you're saving for, and then trying to make sure that you're minimizing the cost in which you're investing your money. So those are the things that you can control. The market returns are uncontrollable by any of us. So again, staying focused on the long term and making sure you have the right level of risk in your portfolio is critically important.

J.R. Whalen: All right. That's Greg Davis. He's Chief Investment Officer at Vanguard. Greg, thank you so much for taking the time to chat.

Gregory Davis: My pleasure.

J.R. Whalen: And that's your Money Briefing. I'm J.R. Whalen for The Wall Street Journal.