2022 forecast: Is a rotation into value stocks on the table?

Strap yourselves in, 2022 is looking like a tough year for investors — with Morgan Stanley going so far as to tell investors to stay away from US stocks. And market strategists are especially wary of a particular type…

Don’t overstay your welcome

The S&P 500 is up 27% in 2021 — nearly triple the average 10%. Pandemic stimulus sent the stock market soaring but here’s how 2022 could challenge investors:

• High valuations — the CAPE ratio is at its highest level since the 2000 crash.
• Interest rate increases — are likely to come as early as July.
• Fed tapering — is starting this month,continuing into mid-2022.

A growth of ~30% per year isn’t sustainable, and yet, investors keep making big bets on the US market. According to a survey by Bank of America, fund managers have invested in US stocks the most in 8 years — but their 2021 outlook says otherwise, expecting:

• Emerging markets (i.e. Europe and Japan) to outperform the US market.
• Bitcoin to be the best-performing asset next year — followed by oil and gold.

What does this mean for stocks?

At the end of 2020, investors favored value stocks — seen by their breakout performance at the start of 2021. But growth stocks quickly rebounded, surpassing value in the past 6 months:

• The Vanguard Growth Index Fund ETF (NYSE:VUG) is up 22.5%.
• Vanguard Value Index Fund ETF (NYSE:VTV) is up 3.5%.

With a post pandemic reopening of the economy and potential rising interest rates in 2022 increasing market volatility, investors could see another rotation — back to value stocks…

Compared to value stocks, growth stocks are much more expensive — and have only been this expensive 2% of the time over the past 20 years.

Investors: Preaching value investments

In the case of this event, Morgan Stanley’s chief investment officer has some preparation tips:

• Sell tech-heavy investments — which are riskier with rising interest rates.
• Invest in cyclical sectors — with the financial sector being her top pick.

The industrial sector — a large component of value indexes — may be getting a lift from Biden’s $1T infrastructure bill signed this week.

Must-read: How can financial stocks benefit from a sector rotation and rising interest rates?