Late last year we unveiled our stock market forecast

for 2022, projecting the S&P 500 would rise to 5,250 and

the Dow Jones Industrials average would climb to 40,000.

Since then, however, equities have dropped, with (now

realized) fears about Russia invading Ukraine and the

recognition that inflation is a more persistent problem than

the Federal Reserve had previously let on, which means

some combination of faster rate hikes or a higher ultimate

peak for short-term interest rates, or both.

Reaching our year-end equity targets would now take

a steeper climb than we previously thought: 20.7% for the

S&P 500 and 17.4% for the DJIA, from Friday’s close. But

we still like those targets and don’t see enough reason to

change them.

As we wrote last week, Russia would likely invade

Ukraine by soon after the Olympics ended, but that such an

invasion is unlikely to change the long-term outlook for

corporate profits. As a result, any drop in equities would

end up being a buying opportunity.

Sure, the Biden Administration might try to exert

pressure on Russia through economic and financial

sanctions. But other countries, like China and Germany,

have strong interests in continuing to exchange freely with

Russia. Ultimately, right or wrong, we think the Biden

Administration is more concerned about managing its

image involving the Russia-Ukraine conflict, for purposes

of domestic politics (like, not “appearing weak”), than

trying to alter the outcome of the conflict itself.

Meanwhile, and for the time being, inflation is likely

to be equities’ friend, not their foe. Companies with pricing

power, commodities’ companies, and materials’ firms, in

particular, should do well.

In addition, the message from our Capitalized Profits

Model hasn’t changed, at least not yet. The cap profits

model takes the government’s measure of profits from the

GDP reports, discounted by the 10-year US Treasury note

yield, to calculate fair value. Corporate profits for the third

quarter were up 19.7% versus a year ago, up 21.2% versus

the pre-COVID peak at the end of 2019, and at a record

high.

The key question then becomes what discount rate

should we use? If we use 1.90%, roughly the current 10-

year Treasury yield, our model suggests the S&P 500 is still

grossly undervalued. But, with the Fed about to embark on

a series of rate hikes and inflation likely to keep running

relatively hot, the 10-year yield is likely to keep rising,

although with fits and starts.

So, to be cautious, we plug in some alternative higher

long-term interest rates. Using third quarter profits, it

would take a 10-year yield of about 3.00% for our model to

show that the stock market is currently trading at fair value.

And that assumes no further growth in profits. With a 10-

year yield of 2.50% all it would take is profits 3% above

the level in Q3 for our model to estimate fair value at 5,250,

which is what we projected for the end of 2022.

The bottom line is that the winds of change are

blowing hard in 2022: COVID is winding down, borders

are in flux, and monetary policy is in for a major and longoverdue

shift. In spite of these changes, we think equities

are likely to rebound from recent strife and work their way

higher this year. The bull market in stocks won’t last

forever. But, for now, it isn’t at an end.