Delta variant in 2020 gives us insight into how Omicron will impact markets now

I’d sum up this economy as what “endemic” COVID will look like for some time to come. Positives and negatives, but likely the positives slowly outweighing the negatives. The new treatment drugs and revised quarantine guidelines could assist businesses struggling with labor shortages from illness and fatigue.

As for investing for next year, I’m looking at what profits analysts are expecting from US stocks and how their expectations have changed even in the face of Omicron, record inflation, and potential interest rate hikes.

Profit expectations have been steadily rising for almost all US equity indexes for the past two months.
1. Currently 2022 S&P 500 expected profit growth has risen to 8.4%.
2. The S&P Small Cap 600 expects 11.4% profit growth in 2022.
3. Both are strong growth rates when looked at in historical context.

The expected profit growth for both these indexes is similar to growth achieved from 2012 to 2014, all years where US equity indexes returned handsome price increases. Both indices averaged about 17% annual returns over that 3 year period. So while we can’t ignore the valuations are still high and inflation will put further pressure on them, I don’t see those pressures being so strong as to make US stock prices decline. We are still overweight US stocks but are careful of entry points for higher valued stocks.

Large cap equities have largely remained in a consolidation range for the last two months of the year. The S&P 500 is making more all-time highs as it edges out if it’s recent trading range in the last trading week of the year.

A consolidation after the rocket like rise earlier in 2021 has allowed for valuations to stabilize and perhaps even approach more historically normal levels for a low interest rate environment. The five-year average forward P/E for the S&P 500 Index is 19.4X, about 13% lower than the current P/E. The market is still richly valued but that doesn’t mean that stock prices must decline. They only must increase less than earnings growth, allowing valuations to compress. Valuations are approaching levels where investors have historically been willing to pay for the promise of future US profits.