In our 2021 Q1 Newsletter, we discussed a stock market that would be threading the needle between the global pandemic, rollout of vaccines, and economic stimulus that propped up the 2020 market. 2021 turned out to be a year of winners and losers with regards to performance; some areas fared very well while others did not. The US stock market proved resilient in the face of Covid variants, inflationary pressures, and supply chain problems that hampered other markets. US large cap stocks (as measured by the S&P 500 Total Return index) returned 28.7%, US mid cap stocks (as measured by the S&P 400 Mid Cap Total Return index) returned 24.7%, and US small cap stocks (as measured by the S&P 600 Small Cap Total Return index) returned 26.8%. These are stellar returns considering the S&P 500 was up 18.6% in 2020.
Impressively, S&P 500 companies grew their earnings by 34.5%. This means price-to-earnings ratios actually fell as market participants were not willing to pay as much for the earnings companies were generating. Also notable is the S&P 500 experienced only one 5.2% pullback, making it one of the least volatile years for US stocks on record.
However, it wasn’t as rosy a picture elsewhere. Developed international stocks (as measured by the MSCI EAFE Total Return index) returned a much more normal, but still very good 11.3%.
Emerging Markets stocks (as measured by the MSCI Emerging Markets index) only returned 1.5% for the year. US Bonds (as measured by the Bloomberg Barclays US Aggregate Bond index) were negative 1.6% as the 10-year Treasury yield rose from 1.07% to 1.51% — remember, bond prices fall as yields rise.
Economically, we saw most of the US economy reopen (with ups and downs as the Delta and now Omicron variant slowed the return to normalcy) and edge closer to pre-pandemic levels of activity. There was also a “Great Resignation” as people reevaluated their current jobs and left the workforce to pursue other interests. This has caused job openings across the US to spike as employers look for new workers to fill the gap.
CHART ONE: Sources: Conference Board, National Federation of Independent Business, US Department of Labor, J.P. Morgan Asset Management.
This Great Resignation is one of the contributing factors to supply chain issues that have caused delays at ports throughout the US and the world. These supply chain problems are also causing substantial increases in inflation. However, US companies have navigated these issues well. So, what should we expect from 2022?
We expect another good year for stocks in 2022. While we won’t put a number on expectations, we look to estimates of future earnings growth and see increasing company profits and earnings which should lead to increasing stock prices.
CHART TWO: Sources: FactSet, Compustat, Standard & Poor’s, J.P. Morgan Asset Management.
Lastly, I want to give some quick observations on a few concerns that arose in 2021.
INFLATION – While the year-over-year increase of nearly 7% seems alarming, we believe inflation is not evenly felt across the masses. If you just bought a used car (up 26%), drive a lot (gasoline up 51%), eat tons of beef and bacon (up 24% and 20% respectively), then your personal rate of inflation will be well over 7%. Truly though, the largest contributor to overall inflation is housing. Home prices are increasing, and rents are creeping up. However, if you have a fixed rate mortgage or own your home outright, your level of total inflation might seem rather benign. Another important thing to note is that during this period, the nation’s lowest level income earners have experienced the quickest rate of increase in income in nearly 40 years. And the consequence? The supply chain shock and wage increases are passed onto consumers in the form of higher prices. How long will this last?
Our best gauge of future inflation is long-term bond yields. The bond market typically gets longer-term calls correct, at least more often than the stock market. Over the last few months, longer-term bond rates have not increased meaningfully, which signals to us that hyperinflation or even higher inflation for more than a year or two is not a current concern. While elevated inflation (3-5% per year) may stick with us in 2022 and possibly 2023, we still believe the base case for inflation over the long-term is closer to 2-3%.
COVID – The Omicron variant is currently spreading quickly throughout the world. It appears to be a milder version, in terms of symptoms, compared to previous strains. The data still shows that the best way to combat more serious cases of the virus is to get vaccinated. While you may still get a breakthrough case, data is showing that you are likely to have milder symptoms if you are vaccinated.
As far as government mandates or further lockdowns, we would think those are highly unlikely. As we head into a midterm election year, politicians are likely to stay status quo and allow citizens to decide what is appropriate for their situation.
BUILD BACK BETTER – Recently, President Biden’s signature legislation was dealt a body blow when Senator Joe Manchin of West Virginia stated he would not vote for the law in its current form. We expect there to be a compromise in the first quarter of 2022 to get a form of the legislation passed, but what will be in the bill could change significantly from where we were a few weeks ago.
Ultimately, we’re constructive as we head into the new year. We do expect 2022 to be more volatile than 2021 for two reasons: 1) Midterm election years tend to be bumpy as there is less clarity on what the government will look like until late in the year, and 2) because 2021 had little volatility. Remember, over the last 40 years the average drawdown during any given year was around 14%. Expect more bumps in returns in 2022.
To hear more from KWB regarding our market outlook, please join us on January 26th for our 2022 Economic Outlook panel. Visit HERE to register for the Outlook webinar. As always, if you have any questions, please contact us and stay safe.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Investing involves risk including loss of principal.
No strategy assures success or protects against loss. The economic forecasts set forth in this newsletter may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Investing involves risk including loss of principal.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa. Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
The S&P Midcap 400 Stock Index is an unmanaged index generally representative of the market for the stocks of mid-sized US companies. The S&P Small Cap 600 Index is an unmanaged index generally representative of the market for the stocks of small capitalization U.S. companies. The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
The S&P Small Cap 600 Index is an unmanaged index generally representative of the market for the stocks of small capitalization U.S. companies.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.