How interest rates will temper stock values in 2022
Stock markets are unlikely to continue last year’s bull run in 2022 as investors seek other opportunities as interest rates rise, according to Wharton finance professor Itay Goldstein. Last week, Federal Reserve officials forecast at least three quarter-percentage-point rate hikes next year, signaling concern over rising inflation. The Fed also said it would scale back asset purchases next year as part of tighter monetary policy.
“Now that interest rates are going to start going up, maybe it will give people other alternatives, and maybe it will start to bring prices down in the [stock] market,” Goldstein said in an interview with the Wharton Business Daily radio show airing on SiriusXM. (Listen to the full podcast above.) “I don’t know if I expect a major pullback, but I certainly wouldn’t bet on prices to continue rising like they have. [in 2021].”
Goldstein said the sharp rise in stock prices this year indicates a dearth of investment opportunities. “People don’t have a lot of places to put their money,” he noted. “The interest rates they can get on risk-free investments are low, so they keep looking for investment opportunities and put their money in the stock market. They put their money in real estate. kinds of other investment opportunities [such as] cryptocurrencies and NFTs (non-fungible tokens, which are digital assets that represent real-world assets). Overall, prices are high and people are increasingly looking for investment opportunities.
Goldstein said concerns about inflation will continue to fuel stock market volatility in the year ahead. “Some of the uncertainties around inflation play into what we see in the market,” he said. “We will continue to see a bumpy ride, but with a fairly high level of risk given the high price levels overall.”
Role of ESG investing
A notable feature of investment flows in 2021 has been the growth of sustainable investing based on ESG factors (or respect for environmental, social and governance values). At the end of the third quarter of 2021, U.S. sustainable funds saw net inflows of $15.7 billion, according to Morningstar data.
According to Goldstein, ESG investing has been dominated by environmental factors, and he expects this trend to continue with growing concern over climate change. “Some of the pressure is not just on politicians but also on the business sector and the idea that the business sector has to contribute and do something for society,” he said. “The environment [aspect] will continue to grow and [it is] something that companies will have to invest in. This will certainly be reflected in these stock prices.
At the same time, Goldstein said the role of ESG factors in driving stock prices is not always clear. He classified investors into two groups: traditional investors who want to see firms generate cash flows and profits, and so-called ESG investors who look not only at profits and cash flows, but also “firms that will do good to society which focus on ESG components.
The investment behavior of these two groups “generates a bit of confusion,” Goldstein said. “When you look at a stock price, what is it? Does it reflect good cash flows and good fundamentals or does it reflect good ESG components? We will continue to see this kind of confusion in asset prices in the future.