What Investors Are Getting Wrong (and Missing) About 2022 Markets

7 min readJan 3, 2022

2021 was a difficult year for investors. It may not appear so on the surface, but it was even more challenging than 2020. This year should prove just as challenging, if not more.

Many investors are raising the alarms on key risks for next year, namely spiking inflation and a series of interest rate hikes. In our view, both are unlikely for 2022. The pent up lockdown-induced price spikes pass; the high economic growth proves to be a mirage; and the upward bias in interest rates consequently ease. Beyond 2022, of course, inflation and interest rates can pose a challenge. With respect to the market, volatile churning at or near current levels while underperforming historical returns is the most likely scenario.

The bigger issue facing the market is a counterintuitive one. It may not seem like it , but there’s less clarity for the markets now than during peak Covid.

It all boils down to two fundamental questions investors need to answer:

1) How much of the behavioral changes in adapting to a post-Covid world are permanent? Sure, the pendulum may swing back some, but by how much?
2) What is the normalized growth rate for companies catering to the post-Covid world versus the companies leading the way pre-Covid? If these behavioral changes are permanent, are pre-Covid growth rates a reasonable benchmark?

The uncertainty around these two questions is the root cause for the bifurcation in the markets. Take a look at the S&P. On the one hand the S&P was up 27% in 2021, but the bulk of that return was driven by just five stocks (Apple, Microsoft, Facebook, Nvidia, Tesla). In fact, the majority of stocks were actually down in 2021. Contrast that to 2020 when the S&P gained 18% and most stocks were close to their 52-week highs. (see notes at end of story for return details)

No matter how you slice it, this year was more difficult than last.

The predictive power of markets is inversely correlated to the rate of change of the economy and society, with technology being the key driver. Typically, behaviors change slowly over time to drive demand. For instance, it took years for our smartphones to become another appendage, happening so slowly most never noticed. The lockdowns, however, forced new behaviors upon us in a matter of weeks creating a demand tsunami.

Understanding the rate of change is critical for markets. When it’s gradual, it is relatively easy to see how sustainable the emerging order will be. The lockdowns completely muddled this process. When investors don’t know what the new norm will look like, things tend to bifurcate between the devil you know and the devil you don’t. This explains why just a minority of companies drove the majority of returns in the market.

Broadly speaking, technology cycles typically last 50 years and we are at the midpoint of this phase. This is where it gets bumpy.

This phase generally consists of broader market returns below historical averages as the market tries to flush out which companies will maintain, or lose relevance in the next phase of technological evolution. Hence, the bumpy ride, even in the most serene circumstances.

According to British-Venezuelan scholar Carlota Perez, who specializes in technology development, it is called the Turning Point. It marks the transition from the Installation Phase (in this case the installation of the internet and cloud infrastructure) and the Deployment Phase which is when the installed technologies fully proliferate through society.

The silver lining of the Covid-induced behavior changes, however, is that the Turning Point is now likely condensed to a year or two compared to the five to 10 years it usually takes.

Think of the world as an interplay between three independent systems: economy, markets, and companies or people. Generally speaking, the stock market price gyrations can be attributed to an uncertainty in one of these areas. Today, however, we have uncertainty in all three.

Whether its swings in GDP, supply chain issues causing crazy price spikes, or bringing workforces back to the office, uncertainty abounds. As a result, market participants are struggling to see through this mess and can’t confidently lean into some type of new equilibrium. This confusion has masked the fact that we were already in the middle of one of the most massive technological shifts we have seen since the introduction of the assembly line.

2021 was supposed to be the year that Covid ended. Yet here we are again, with Omicron driving closures and delays. Fortunately, we are much better equipped, so Covid will continue to slowly drift into the rear view. However, the uncertainty as to how much of behavioral changes are lockdown-induced versus permanent continues to rattle markets.

Simply put, investors do not know what the normalized growth rates will be for both legacy and next-gen companies. Unfortunately, we won’t know it until lockdown-induced growth rates normalize globally, or probably another year from now.

People consistently underestimate the impacts of technological and societal changes. In 1998 Nobel Prize-winning economist Paul Krugman opined: “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machines”. This is no knock on Mr. Krugman, but broader commentary on how we are hardwired to overestimate the near-term and underestimate the long-term.

The other factor to consider is Buffet’s market cap-to-GDP ratio hovering at all-time highs of 200%. Compare this figure to the previous high of 141% during the dot-com bubble.

You were lucky if you engaged the S&P, but many stock picking funds took major hits. Just look at the innovation focused Ark Funds, down 24% in 2021. Although their bet on the future is likely right, the aforementioned tension is causing a splintering of returns.

In combination, we have very high uncertainty and very high aggregate valuations.

Add to this the fact that whenever profound improvements in productivity occur the drivers of the market radically change. Just look at the turn of the century with the advent of the assembly line. The Dow components turned over by 70% for two consecutive decades in 1910 and 1920 as the companies that used the railroads displaced the steel companies that built them.

It’s no different today. Consider today’s rail riders as the companies that leverage the existing internet and cloud infrastructure as the dominant players of the Deployment Phase. A large degree of turnover of the S&P is in the cards, and likely commencing sooner rather than later.

Thus looking into 2022, here are the four themes we look for:

Permanence of behavioral changes

Becomes increasingly clear the world is not going back to the way it was. This translates to lower than average growth for legacy companies and higher than average growth for next-gen companies compared to pre-Covid rates. The rate at which companies can scale today is underappreciated.

Companies that help decentralize will win

Companies that best help navigate these permanent behavioral changes by embracing and facilitating decentralization are best positioned to prosper.

Turnover in the S&P

The strength of the current composition in the S&P begins to see cracks. This yields below average market returns relative to historical averages.

Inflation and GDP below expectations

The magnitude of the lockdown induced disruption becomes clear. As we lap those distortions, the rate of growth and price increases moderate, perhaps going negative on a year over year basis. In other words, the Fed rate hikes may not materialize.

The days of riding the broader market indices are likely behind us.

The path forward must increasingly be managed through security selection. Technology always moves forward independent of broader economic growth rates. As a result, companies with secular advantages have historically served as a “natural hedge”. Maintaining exposure to such companies with reasonable valuations has been a successful strategy during similar periods.

In other words, Cathie Wood is far closer to being right than wrong over the long-term.

Good luck in 2022.

NOTES

S&P: 54% of stocks within the S&P are actually down in 2021, and 37% down more than 10% from 52-week highs. Contrast that to 2020 when the S&P gained 18% in broad-based form, as 70% of companies ended within 10% of their 52-week highs.
The NASDAQ tells a similar story. In both 2020 and 2021, 62% of stocks in the NASDAQ were down for the year despite the index rising 43% and 21%, respectively. Hence, the majority of stocks were down. Moreover, 48% of stocks were down over 10% from their 52-week highs in 2021, compared to just 30% in 2020.

Clockwise Capital is an asset management firm with a private equity approach to the public markets. We focus on the meaning of time and the role it plays in people’s lives. We believe the essence of a great investment resides in the ability of a company to either save their customers time, or improve its quality. We understand how technology evolves to drive these two factors, which we believe define human progress. As a result, we search for securities with cyclically depressed valuations whose companies save time, thus using secularly advantaged industries to build a concentrated portfolio. With each series of investments our goal is to optimize edge, maximize return, while also minimizing correlation. This allows our portfolio to maintain a liquid, low duration fixed income balance, ready to capitalize on market volatility, while still generating market beating performance.