Up or Down? Flat!

As a rule of thumb, if the stock market gains in the first five trading days of the year, the whole year will see gains. Unfortunately, this year the S&P 500 went down by 2.4% in the first five trading days.

Over the same period, the Russell 2000 Index of Small and Medium size companies went down by 2.7%, undermining the idea that Small and Medium caps with a high Beta will outperform large companies.

NASDAQ out of three major Indexes took the biggest hit. It dropped by 5.3%! This indicates a massive run from the Tech companies. Share prices for expensive safe-haven FAANGM, with proven earnings and business models, dropped along with small and medium size growth names (also with high multiples, but no earnings). The funds have been flown from the Tech sector towards Energy, Travel and Leisure, Banks and Consumer Staples.

Fed plans to increase interest rates sooner than expected, growing inflation and Omicron seem to be clear by now. However, further correction of the high PE stocks in the Tech sector over January is likely for many companies, where valuations remain higher than historic averages and growth outlook is deteriorating.

The Energy sector has been one of the top performers over the last three weeks, due to the unbalanced supply and demand resulting from massive long-term underinvestment and lagging performance in November and early December. In 2022, we expect a strong performance from energy companies to continue. However, in the short-term after 15.4% gains since December 20, and with the sector approaching 52 weeks high, it seems to be due for a breather.

Surprisingly, since the beginning of the year Utilities dropped by 1.3%. This is not intuitive, as long-term stable businesses with predictable earnings and dividends are good hiding place in volatile markets. The answer probably relates to the expectation of higher rates. Higher rates have a negative effect on the valuation of dividend paying companies, unless the dividends increase significantly or management decides to buy back shares.

Financials are among the companies favored by investors, as higher interest rates will result in improved profitability. Consumer Staples has also went up by 1%, indicating a potentially profitable year for the companies in this sector.

Most strategists forecast the S&P 500 to grow in 2022. For example, Tom Lee, a strategists from Fundstrat, forecasts that the S&P 500 will reach 5,100 by the end of the year (6.5% growth from January 3). At the same time, the market expects a lot of volatility, especially in the first part of the year with the revenge rally in 2H22.

It looks like 2022 is not going to be a great year for passive investors in the S&P 500, as FAANGM companies (under pressure for high valuations) represent a majority of the Index. Investing in companies in Energy, Travel and Leisure, Banks and Consumer Staples sectors worked well during the first five trading days of the year and there is a good chance that these sectors might have strong performances in January and possibly in the first half of 2022.

For individual stock selection, please see the top 10 holdings in the Vanguard Indexes for Travel and Leisure, Energy, Financials, Consumer Discretionary and Utilities.

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