Risk assets had a terrific 2021 with the S&P 500 showing a total return of 29%. The stellar year was led by cyclical sectors, which tend to outperform when economic growth is strong.

Energy led all sectors with a return of 55%, while Financials (+35%) and Technology (+35%) outperformed the market. Real Estate (+46%), led by shipping centers, apartments, and a rebound in regional malls, also outperformed.

Defensive sectors, which tend to outperform during periods of economic weakness, underperformed in 2021 with above-trend economic growth favoring cyclical sectors for better-than-expected profit growth. Utilities (+18%), Consumer Staples (+19%), and Health Care (+26%) all underperformed the broader market with profits that are less sensitive to economic growth.

As we begin 2022, leading indicators continue to suggest above-trend economic growth that’s favorable for stocks, especially cyclical sectors, which should continue to see above-average profit growth. We see several key factors supporting the economy and stocks as discussed below.

Demand has been surging since the economy reopened and we expect this to continue in the new year. Households are in great shape, with net worth that has surged to record highs, along with stock prices and home values. Consumers have accumulated over $2 trillion in excess savings and have record-low debt service levels. The labor market is also very healthy with 11 million job openings while last week’s initial jobless claims continued to hover at lows not seen since 1969, indicative of a very tight labor market.

This suggests healthy demand will continue, to the benefit of consumer stocks. Significant pent-up demand still exists for travel and leisure, which should benefit the stocks in these industries, especially as the pandemic ultimately fades. Housing should continue benefitting from pent-up demand and a lack of inventory.

Businesses are also on solid footing with debt as a share of net worth near the lower end of its historical range, borrowing costs near all-time lows, and profit margins at all-time highs. Corporate confidence is elevated and banks are willing and able to lend for future expansion plans.

While it is expected the Federal Reserve will begin raising interest rates later this year, financial conditions remain accommodative with short-term interest rates still at the zero-bound. The Financial sector should benefit from interest rate normalization in 2022, after benefitting from healthy economic growth and low defaults in 2021 that should continue in 2022. Healthy financial institutions are well positioned to finance future purchases of homes, autos, and other durable goods in 2022, to the benefit of economic growth.

We expect the Energy sector to benefit further from above-trend economic growth. Oil inventories are now below long-term averages with strong reopening demand absorbing excess supply. Meanwhile, producers, including Saudi Arabia, Russia, and the shale drillers, remain disciplined with new supply. This should continue supporting oil prices and the sector’s profitability.

Technology should continue to benefit from the many secular tailwinds it has experienced prior to and during the pandemic and we view the sector as a core holding. However, valuation is full and potentially higher interest rates could pose a valuation headwind. Health Care also has favorable secular trends, led by aging demographics, and we continue to see the sector as well positioned with defensive growth.

The Industrial sector should benefit from further above-trend economic growth and is expected to see the highest profit growth of all sectors in 2022. Industrials and Materials are also beneficiaries of strong demand for commodities due to economic growth, higher infrastructure spending, and the movement to clean energy which involves significant demand for base metals.

While Consumer Staples and Utilities benefit from stable earnings and dividends, their projected 2022 earnings are below the markets. Given that cyclical sectors are bigger beneficiaries of above-trend growth, this could pose a headwind for their relative performance as we start the new year.


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