By Lewis Krauskopf

NEW YORK (Reuters] – While the U.S. stock markets are set for a triple-peat in stellar annual returns, chances of a comparable performance in 2022 could be impacted by a Federal Reserve that is more hawkish, slowing earnings growth, or a persistent pandemic.

The benchmark index is currently on pace for an 87% increase since 2018, with just over one week remaining in 2018. This marks the best performance in three years in nearly two decades. Following double-digit returns for the past two years, benchmark index is now up 25%.

If history is any guide, next year’s gains may be less impressive, though not necessarily poor.

The S&P 500 has notched three straight years of double-digit returns nine times since 1928, according to Jessica Rabe, co-founder of DataTrek Research.

DataTrek discovered that gains in the years following these periods were on average weaker than the overall 11.6% return. In five years, stocks rose and in four others fell.

Rabe stated in emailed comments that Reuters: “The chances of this type of positive momentum continuing into the next year are a coin toss.” “But the S&P’s performance has historically proved asymmetric as positive returns have been much larger than negative returns in the fourth year.”

A Reuters poll of strategists earlier this month projected the S&P 500 would finish 2022 at 4,910, which is up 4.5% from Wednesday’s close.

The Fed’s three projected interest rate hikes in 2022 – a more aggressive path than markets were expecting weeks ago – will be at the top of investors’ minds, threatening to drive up bond yields and undercut comparatively risky assets such as stocks.

The central bank raising rates in response to the economy may boost equity markets.

The S&P 500 has returned an average 7.7% in the first year the Fed raises rates, according to Deutsche Bank’s study of 13 hiking cycles since 1955.

“We still see a decent environment for equity investors in 2022, although we don’t expect the types of gains that we have seen,” said James Ragan, director of wealth management research at D.A. Davidson, who is expecting mid-single-digit growth for the S&P 500 in 2022.

Ragan favors those sectors which will benefit the most from a strong economy. These include financials, materials and industrials. He also prefers companies that are able to pass on price rises in an inflationary environment.

“We think it is still a good overall GDP growth environment, should enable companies to still grow earnings, but we have concern about valuations,” Ragan said.

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Higher rates and rising bond yields could put pressure on stock valuations already stretched. As projected cash flows from corporates will be discounted at lower rates in stock valuation models, they may lead to stock valuations that are more expensive.

The S&P 500 trades at about 21 times forward 12-month earnings estimates, compared with its historic average of 15.5 times, according to Refinitiv Datastream.

While strong earnings can still bolster the case for stocks, S&P 500 company profits are expected to grow by 8.3% next year, after a nearly 50% rebound in 2021, according to Refinitiv IBES.

Michael Arone (chief investment strategist at Investing.com), stated that while earnings growth and revenue growth are necessary to propel stock markets higher, the danger is when they fail. State Street (NYSE:) Global Advisors.

The earnings picture is also clouded by uncertainties over COVID-19, as the Omicron variant https://www.reuters.com/business/healthcare-pharmaceuticals/how-worried-should-we-be-about-omicron-variant-2021-12-14 takes hold around the world. Investors aren’t sure that the U.S. will resume its lockdowns, but consumers may be more careful due to an increase in Covid infection, according to Oxford Economics. This note was based on 8.1% record-breaking growth and projected that consumer spending would rise by 4.3% by 2022.

The U.S. midterm elections will in November be a wildcard for investors. With President Joe Biden’s Democratic Party controlling Congress, it is seen as uncertain.

We will have to wait and see if technology stocks and growth stock, who led the U.S. markets for much of this decade, are able to maintain their strength. These stocks are more sensitive to yield increases because they depend on future earnings.

If mammoth growth stocks fail, it could spell trouble for wider markets. Gains in six companies – Microsoft Corp (NASDAQ:), Apple Inc (NASDAQ:), Google parent Alphabet (NASDAQ:) Inc, Nvidia (NASDAQ:) Corp, Tesla (NASDAQ:) Inc and Meta Platforms Inc, formerly Facebook (NASDAQ:) – accounted for about one-third of the S&P 500’s total return in 2021 as of Tuesday’s close, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

“We may start to see an underperformance in tech and an outperformance in sectors that are under-appreciated,” said Andre Bakhos, managing director at New Vines Capital LLC in Bernardsville, New Jersey. “By the nature and design of the S&P, you would probably get a lower market.”