Record Earnings Could Drive Market Higher in 2022

S&P 500-member companies are expected to report record net profit margins in 2022.

“Even with a difficult comparison to (expected) record-high earnings growth of 45.1% in Calendar Year 2021, analysts still expect the S&P 500 to report high, single-digit earnings growth in Calendar Year 2022,” says John Butters, Vice President and Senior Earnings Analyst at FactSet, in a recent research note.

“The estimated (year-over-year) earnings growth rate for Calendar Year 2022 is 9.0%, which is above the trailing 10-year average (annual) earnings growth rate of 5.0% (2011 – 2020).” 

Earnings Growth Will Be Broad

Earnings growth will extend across almost every sector included in the S&P 500 index. Specifically, ten of the 11 sectors making up the S&P500 index are expected to report year-over-year growth in earnings.

Top on the year-over-year earnings growth list is Industrials, which are expected to grow by 35.9%, followed by Consumer Discretionary, up 32.2%, and Energy, up 28.4%. The only sector that is expected to show a decline in earnings is financials. 

All three sectors leading the earnings gains are cyclical sectors benefiting from the recovery of the world economy from the pandemic recession.

What Can Go Wrong?

Making predictions one year out in challenging environments is a tricky business. There are always a few things that can go wrong, making these predictions useless.

What can go wrong this time around? The answer: weaker economic growth in all the major economies worldwide and elevated inflation. 

Several economic reports released recently provided a mixed picture of the state of the U.S. economy. For instance, the November payroll report that came out a couple of weeks ago showed that the U.S. job growth stalled due to labor market frictions and supply-side bottlenecks that constrain hiring.

Meanwhile, job creation is crucial for every recovery, especially the current economic comeback, which has been fueled by government benefits that ended in September. Moreover, weak economic growth is usually followed by meager income gains, weak consumer spending, and tepid overall economic growth.

Then there’s the Fed’s beige book, released mid-October, confirming that the U.S. economy expanded at a “modest to moderate” rate in September, with growth uneven across districts. Meanwhile, the beige book confirmed that inflation remained elevated across the country.

A survey of the business conditions across the U.S. compiled by the 12 Federal District Banks and published eight times a year, the beige book is a crucial document for FOMC meetings that determine the nation’s monetary policy direction, with the next meeting coming up this week.

Financial markets follow these meetings closely, as they can change the game. For example, this time around, markets expect FOMC to announce the beginning of tapering, the rolling back of its bond-buying program to limit liquidity to fight inflation. 

The problem is that tapering is coming at a point of a resurgence in COVID-19 infections worldwide, which could slow down the economic recovery and eventually push the economy into another recession. Some believe that wouldn’t be good for cyclical stocks, which are expected to lead Wall Street. Recessions depress consumer demand, which takes its toll on the top line of listed firms.

Meanwhile, across the Atlantic eurozone is facing similar problems. The Eurozone economy grew at an annual rate of 3.9% in the third quarter of 2021, following 14.4% growth in the second quarter, when the economy recovered from the pandemic recession. Meanwhile, Eurozone inflation is running at 4.9%, prompting the European Central Bank (ECB) to pursue its own tapering when it meets this week.

The Bottom Line

Things look up for S&P 500 companies in 2022, provided that economic growth does not weaken further or inflation doesn’t get out of control.