There’s plenty for investors to worry about these days, from Covid to Fed tightening to high asset prices. But Darrell Cronk, president of the Wells Fargo Investment Institute and chief investment officer of wealth and investment management at Wells Fargo, says recent knockout earnings and other factors should offset those issues. “I get the angst around valuations, the Fed, inflation, and Covid,” Cronk says. “But I think you have to look through that and see stronger earnings growth, stronger economic growth, than most anticipate.”
Cronk and his Wells Fargo colleagues think the S&P 500 will end the year between 5100 and 5300. Rival firms UBS (4850), Bank of America (4600) and Morgan Stanley (4400) have less rosy predictions. Walking Barron’s Advisor through the firm’s 2022 outlook, Cronk says Wall Street is overestimating Fed tightening and overlooking earnings momentum. He argues for 3% or 4% exposure to distributed-ledger and digital-asset investments. And he says we’re early in a commodities super-bull cycle.
To what extent do you think Covid will continue to weigh on the economy in 2022? Last year was really strong economically. We’re tracking fourth-quarter GDP to be 7.5%, maybe 8%, and the whole year probably somewhere north of 6%. We think we still see normalization of growth but still a 4.5% GDP for calendar year 2022. Four and a half percent real GDP growth is not something we’ve had the luxury of having for multiple decades. Certainly Omicron or maybe future variants of Covid could impede some of this, but there is now reluctance among political officials to shut down economies and businesses and put stringent limitations on travel, like we saw in the first and second quarter of 2020. So it will still be with us, but I think growth will actually power through.
What factors will stock performance turn on in 2022? There are four key areas to watch outside of the headline-type stuff like Covid. I’ve got my eye on credit spreads to see whether they widen with any kind of with any kind of materiality. I also am paying very close attention to the shape of the yield curve. We see it mildly steepening into the year.
The next one is all about revenue and margins. People want to talk about companies’ profit margins being at all-time highs, and that will drive equity prices in 2022. I don’t disagree with that. But I would argue a more important line is the top line, the revenue line. If you can drive sales growth, margins will come—and we don’t see the onslaught of deterioration of margins or revenue that a lot on the Street see these days.
And fourth is the path of the dollar. At this time last year, I think most people expected the dollar to weaken for the majority of 2021. In fact, it had one of the strongest years in many years. And if the U.S. economy continues to outperform the global economy, which we expect to be the base case next year, it may be a less exciting year for the dollar. But we don’t expect the dollar to decline against global currencies. In fact, we see it mildly appreciating this year.
Wells Fargo is pretty optimistic about stock returns for 2022, correct? That’s true. The midpoint of our [S&P 500] target is 5200, with a range of 5100 to 5300. From today’s level, that’s up about 9% Tack on another, call it, 1.5% dividend, and you’re into lower double digits.
What many have overlooked is that for the past three years in a row, the S&P 500 has given you almost 20% lockstep each year, which is especially unusual given that we’ve come through a global pandemic and a sharp and steep recession. Yet the equity market kind of didn’t blink all the way through that. So we still think 2022 is a story of stronger demand and stronger earnings than most people expect.
The past six quarters in a row, we have walked into earnings season and come out the other side beating the consensus estimate by double digits. That’s just never happened. So we think the Street is still underappreciating earnings. And a lot of people are fearing what the Fed may do here. But if you go back through history, the S&P 500 typically peaks at the end of Fed tightening, not at the beginning. And I think the Street’s missing that.
Do you think 2022 is the year the Fed takes away the punchbowl? I think Fed policy is already tightening. If you go back to March of last year, the Fed’s balance sheet was growing at 80%; today it’s growing at 20%. The M2 money supply in March was growing at 28% or 29%; it’s growing at 13% today.
So we think the Fed starts to remove the punchbowl in the form of finishing tapering. And then it probably has two interest rate hikes next year, something like June and then either September or December. We do think that where the markets are pricing in three to four hikes is just too aggressive.
Wells is forecasting around 4% inflation next year. How do you see that playing out? We do think inflation stays relatively high in the first quarter, maybe the first half of 2022, but has moderated considerably by this time next year. There’s already good evidence that commodity prices are flattening out.
The important thing about inflation, which I think people have to really cement in their heads, is inflation is a year-over-year percentage change. So for it to go up 5%, 6%, 7%, 8%, 9%, which some people fear, is very difficult to do mathematically coming off last year.
If my portfolio was positioned well for 2021, how should I pivot for 2022? For 2022 we want to be overweight domestic over international. You want to still be overweight large over small as we move from early cycle dynamics to midcycle drivers, which means fading more of your small-cap, emerging market, high-beta earnings cycle-type winners.
On a sector basis, you really want to have exposure to cyclical and growth—things like financials, industrials, technology, and communications—over anything defensive. We would stay underweight utilities and staples: They were underperformers last year by wide margins, and we continue to think that’s not the place to be.
What should investment advisors do about bonds, which have been a drag on performance and have been losing their correlation advantage? We’re certainly bearish this year on the bond market. I think it’s time for investors not to exit bonds, but to play defense. It means moving up in quality, getting out of junkier stuff, shortening your duration and average maturity so you’re not taking a bunch of risk at a 1.5% 10-year Treasury.
We do think rates grind higher into 2022. Our year-end target for the 10-year is 2.25%. So a 1.5% move to 2.25% would certainly put a headwind on bond prices. And with low cash flow yields today, we think we could be looking at another year of flat or more likely negative [real] returns for fixed income.
How do you recommend playing private assets in 2022? There is probably record amounts of capital chasing finite opportunities there. I think every firm we’ve talked to is out raising a fund, and in most cases, generally a pretty sizable fund. So the risk in that piece of the market is that that large amount of capital has to get invested somewhere, and it may settle for not-as-attractive opportunities or lower IRR (internal rate of return)-type opportunities. So I think alternatives play a big role in 2022 but you’ve got to be really careful and selective.
What kind of guidance would you offer on commodity investing? We still very much like commodities; it’s one of our higher conviction ideas. We went overweight commodities in portfolios about 18 months ago, and that’s been one of the better accretion factors. History teaches us clearly and often that when commodities move in cycles, whether those are bear cycles or bull cycles, they tend to do it over long periods of time—they’re called super bear or super bull.
We think you’re early stage into a super-bull type opportunity in commodities, probably only year one or year two of what tends to typically be an eight- to 10-year-type cycle.
And yet because of 10 or 12 years of commodity underperformance prior to these past 18 months, most portfolios have underweight exposure strategically to commodities. We’ve been pounding the table on it for the past 18 months and continue heading into 2022 to try and get investors to at least get up to where we think those strategic targets should be.
When advisors ask you what they should tell their clients about cryptocurrencies, what are you telling them? We actually like crypto; we have some options on the platform today. Most of your direct exposure, your nonfutures exposure, is done through private placement vehicles, which is our preference. If you look at Bitcoin, it was arguably the best performing asset of 2021 from a rate-of-return standpoint, and has been for the past decade.
And certainly everybody talks about the distributed ledger and digital assets capabilities, but we think they’re transformational—almost something akin to the iPhone in 2007. We think in the next decade you could have brand-new sectors, industries, certainly businesses spun out of what’s going to evolve here. We think you should have probably somewhere around 3% or 4% exposure. Don’t go crazy with it, but we think it’s here to stay. In fact, we did a study that found it actually provides really nice diversification benefits to portfolios because of the separate, idiosyncratic path it takes.
Do you fold into that this Web3 stuff? How much real opportunity is there right now versus just hype? We’re not quite onboard with that yet. We haven’t found a viable way to gain what I’d call decent exposure there. So it’s not part of our 2022 recommendation or narrative, but I think it’s an important area to watch.
What’s your best guess about where we’re going to come out on tax legislation? Three months ago, we were constantly talking about how we would have an increase in capital gains tax, in corporate taxes, and certainly an increase in the income tax for wealthier individuals. All of that has basically been shelved through the negotiation process. So looking at 2022, If you make less than $10 million of adjusted gross income, you’re likely not to see a tax increase, even if Build Back Better ultimately passes, which we expect it to do.
What was a fairly significant risk has flipped, almost to the point where if you start looking at some of the stuff around child tax credit extensions, state and local taxes adjustments, and everything else, you’ve turned what was a fiscal headwind into almost a little bit of a tailwind.
Any final thoughts to share with our advisor readers? I worry that the Street, because of all the bricks in the wall of worry, has turned too pessimistic heading into the year. It’s important that you don’t pull excessive amounts of risk out of your portfolio right now. We’re just moving into midcycle dynamics. I don’t think we’re anywhere close to late-cycle dynamics. Nobody’s predicting a recession in 2022. As I said before, the S&P tends to peak at the end of Fed tightening cycles, not the beginning. I get the angst around valuations, the Fed, inflation, and Covid. But I think you have to look through that and see stronger earnings growth, stronger economic growth, than most anticipate.
We find ourselves headed into 2022 more on the optimistic side than most of the Street. A lot of people out there have, you know, 4400 for an S&P target, which is 200 to 300 points down from today’s low. We just don’t see that.
Thanks, Darrell.
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