- Two Deutsche Bank analysts have forecast the S&P 500 will hit 5,250 next year.
- The analysts say they expect US company earnings to stay “stronger for longer” during 2022.
- They break out three sectors in the index that are likely to offer investors the best opportunities.
The S&P 500 and many other leading stock-market indexes have been on a meteoric rise since the crash triggered by the onset of the pandemic in February 2020.
Because of the strength of the climb and the magnitude of the earnings multiples required to achieve it, many consider markets, particularly US equities, overheated.
On the current trend, with cyclically adjusted earnings per share of $174.50, the price-earnings multiple of the S&P 500 is 26.3 times, according to Deutsche Bank. This is the highest level since the late 1990s bubble when it peaked at 35 times.
But Deutsche Bank’s equities-research team hasn’t adopted a a bearish outlook for 2022.
The analysts Binky Chadha and Parag Thatte have forecast the S&P 500 will finish next year at 5,250 points. That is nearly 8% north of its 4,886 points at the time of writing.
That forecast does not mean there won’t be dips along the way, especially given the uncertainty the Omicron variant is creating and the trajectory of inflation and US interest rates. But when all is said and done, they forecast that investors who buy US stocks now will be comfortably achieve profit by the end of next year.
The Deutsche Bank analysts’ projection is underpinned by a few key beliefs. Chief among these is the view that the S&P 500 will have 10% earnings growth to $230 in 2022 and 6.5% in 2023 to $245.
“On the upside, there are a number of reasons for why earnings may well get and remain stronger for longer,” they said. “Household and corporate balance sheets are strong, savings rates are very elevated relative to the rise in value of assets to which they have been tied historically indicating spending power, while new rounds of the virus could re-stimulate already elevated levels of demand for goods, capex, and increases in MCG+Tech sales.”
The analysts do not appear to have too much fear that the Omicron variant will disrupt equities markets. If anything, it could give stocks a further lift, they said.
“The disruption to services during the pandemic was a big contributor to outsized demand for goods and technology,” they said. “Three-fourths of the S&P 500 by market cap comprises industries that saw a large boost through the pandemic and whose activity levels are well above trend.”
The picture is not entirely rosy, though, as Chadha and Thatte said there were many possibilities around their baseline view for 2022.
“On the downside, overall activity levels for S&P 500 industries are already well above trend levels,” they said, “indeed in the aggregate at levels where the cycle has often peaked; equity valuations are very rich and wherever signs of slowing have been clear, stocks have been hit hard; the Fed looks set to accelerate the withdrawal of stimulus and rate hikes may significantly slow demand for housing and autos, two key sectors on which the strength of the growth outlook is dependent.”
Turning to how best to make money from the continuing market rise and earnings growth, the analysts pointed to the three sectors they believed were going to be the best plays for 2022.
Energy stocks have been rated as overweight principally because of their relative value. “Energy earnings have been trending down for over a decade, dragging valuations down in turn,” they said. “A stabilization in earnings could see a re-rating in the cheapest sector in the S&P 500.”
This sector was one of the worst-hit during the depths of the pandemic, when US crude oil briefly cost less than zero as activity all but ground to a halt. But this year, as economies have reopened and trade and travel have bounced back, the oil price has roared back to life. In fact, the energy sector is one of 2021’s top performers, with a gain of almost 50%, compared with a 24% gain in the S&P 500.
Materials names tell a similar tale. These stocks are at the bottom of the relative valuation range of the past few years and should catch back up with other sectors to a degree where they are likely to outperform the rest of the S&P 500, the Deutsche Bank analysts said.
With the global economy coming back to life, construction has been one of the driving forces in the rally across the industrial-materials sector, which lifted lumber, copper, iron ore, and aluminum, among others, to record or multiyear highs. Years of underinvestment in extraction and production have created supply deficits in a number of key markets, such as copper.
According to Chadha and Thatte, financials stocks are another good bet for 2022, as they are “disconnected from growth and completely tied to rates.”
In other words, as the Federal Reserve makes moves toward tightening conditions to rein in inflation, banks and other finance-sector stocks may benefit, independent of the degree to which we see growth.
Read More: Deutsche Bank lays out its picks for the best equity sectors to own in 2022 as investors