With Omicron And Tapering Looming, Here’s What To Watch In 2022

2021 has been a tricky year as investors navigated the COVID pandemic, vaccine rollouts, the re-opening of the economy, the start of a new presidential administration, the beginning of a tightening cycle by the U.S. Federal Reserve, and finally the emergence of the highly contagious omicron variant. Until recently, U.S. economic improvement combined with the Fed’s easy monetary policy had driven stocks higher. Recently though, a combination of factors has weakened stocks, with the S&P 500 off 4% from all-time highs, the NASDAQ NDAQ off 8%, and the Russell 2000 off roughly 14% from the high it reached seven weeks prior. In fact, the damage is actually worse than it appears if we examine breadth and the number of stocks more than 20% off previous highs. Roughly one-third of stocks on the S&P 500 are down more than 20% from highs; the NASDAQ is worse off with roughly 50% off 20% or more; the Russell 2000 has more than 70% of stocks off 20% or more. At the same time, the Fed has accelerated their tapering of bond purchases. Expectations were that the Fed would wind down its purchases over an eight-month period, but this has been curtailed to roughly four months, with the program expected to be completed by mid-March 2022. Finally, the speed at which the omicron variant is spreading is raising the possibility of global lockdowns and restrictions again, which is increasingly likely to slow the global economic recovery and lead to downward earnings revisions for the first half of 2022. With all this as a backdrop, let’s look ahead to 2022—both in terms of its setup as well as investment themes that may hold promise for the New Year.

2021 had a positive historical precedent since it was the first year of a presidential administration and the presidential cycle. Unfortunately, the second year of the presidential cycle and an administration usually has significantly weaker stock performance (see table below). Small stocks, represented by the S&P 600 and the Russell 2000, averaged losses over the period 1988–2020 during the second year of the presidential cycle. Large stocks, while achieving positive returns, had lower-than-normal performance during this period, with the S&P 500 and NASDAQ both averaging a gain of only 2%.  

*Russell 2000 and S&P 600 indices’ history from 1988 and 1989, respectively.

While 2021 was a good year for stocks, there is not much of a carryover effect into the next year (see table below). If 2022 ends up being a year of losses for equity investors, it would not be out of the ordinary, as it has happened three times following the thirteen years where the S&P 500 rose 20% or more between 1970 and 2020.

Technically, the major averages offer a mixed picture at best. The S&P 500 remains in an uptrend, although early this week it broke through its 50-DMA once again. This has occurred several times over the past 18 months, but in each case it found support at or just below the 100-DMA. It is testing that level now; a break below there would leave the next support 4% lower at the 200-DMA.

Similarly, the Nasdaq failed to hold its recent retake of the 50-DMA and has broken its 50-DMA and 100-DMA over the past several sessions. It has found support at or just below the 100-DMA on multiple occasions over 15 months, so the current level is clearly key. If it cannot retake the 100-DMA quickly, the 200-DMA is in play at 4% below.  

The small-cap Russell 2000 looks the worst, having sliced through both its 50-DMA and 200-DMA in late November and then failing on a recent attempt to retake either. It is now testing a major support level at the lows of a range that has been established since January, a break of which could drive it decisively lower. 

Currently, most stocks in the market are trading below their 50-DMA, with only 48% of the S&P 500, 20% of the Nasdaq, and 25% of the Russell 2000 above this moving average.

A great deal of speculation has come out of the market, which can be seen in the area of new issuance. IPOs, which had been very strong, have slowed recently both in terms of issuance as well as price performance. December has seen only three IPOs, compared with the peak month of the year, July, which had 64. It could still be possible that this year was the start of a multi-year acceleration in the number of new issues (see the IPO chart below with a spike in 1991, leading to several more years with high totals). But the factors working against this are weak performance of the 2021 new issues and the current de-risking spilling over into 2022.

The sample is IPOs with an offer price of at least $5.00, excluding ADRs, unit offers, closed-end funds, REITs, natural resource limited partnerships, small best efforts offers, banks and S&Ls, and stocks not listed on CRSP (CRSP includes Amex, NYSE, and Nasdaq). It also excludes SPACs.

SPACs have also cooled. Listings have exploded in 2021, with more than 500 SPAC offerings in the first three quarters of the year. However, the median new SPAC is down in price for the year and the number of future offerings is beginning to decline.

Despite the very high number of new issues this year, the median IPO is down 16% from its offering price and 49% from its 52-week high, greatly underperforming the overall market.

Annual IPO Trends, 2020

Further, demand for older IPOs (one to three years since pricing) has also waned in 2021. The median year-to-date performance of stocks with new issue dates from January 2019 through December 2020 is -39%. These stocks are a median of 63% off 52-week highs! The Renaissance IPO ETF (IPO), which houses many of these stocks, reached nearly 30% off highs initially in May from a February peak, then after months of a recovery attempt has given up most of the progress in just a few weeks. Its RS line compared with the S&P 500 is near 52-week lows and falling.

Overall, given the likelihood of omicron slowing the global and U.S. economies as well as historical and technical factors, it appears that large-cap stocks are favored to outperform small caps, at least to start the year. In terms of growth versus value, the trends are less clear. Recently, both technology as well as high-growth consumer cyclical stocks have weakened. While some areas of value have performed better, they tend not to be more cyclical but rather defensive, like large financials, staples, and utilities.

Both the staple and utility sectors are showing a good deal of outperformance in recent weeks while coming from positions of extreme underperformance over the trailing 12 to 18 months. SPDR ETFs for each (XLP, XLU) have made all-time highs recently, an impressive feat in absolute terms given the market pressure. Both indices have potential for a continued reversion to the mean, supported by market weakness and the typically weak setup going into the second year of a presidency. 

The key things to watch over the coming weeks and months will be whether the S&P 500 and Nasdaq can retake their 100-DMA or if they trade all the way down to the 200-DMA; whether or not the Russell 2000 can hang onto the long-term support at which it now sits; and whether growth stocks (software, IPOs, clean energy, etc.) can work through ongoing bases to provide more attractive technical setups near their 52-week highs. I would like to paint a brighter picture going into the end of the year, but until these factors improve, I advise you to stay cautious.

Kenley Scott, Director, Global Sector Strategist at William O’Neil + Company, an affiliate of O’Neil Global Advisors, made significant contributions to the data compilation, analysis, and writing for this article.

DISCLOSURE:

No part of the authors’ compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.

Source: Forbes