“We are choked with news and starved of history.” – Will Durant
“Learn how to see. Realize that everything connects to everything else.” – Leonardo da Vinci
“Life and investing are long ball games.” – Sir John Templeton
Every year now for more than a decade Magellan Financial has been sharing with you, our cherished clients, prospects and friends our thoughts on the world of investments in the coming year. This is our chance every year to take a step back to evaluate what happened over the past 12 months with an eye toward the next 12 months.
There are times we are spot on, others where we miss the mark. Prediction is not an easy game. And unlike many talking heads on television, we have a written account of our thoughts for all to judge. Sure, you can go back and see if Jim or Bob or Maria gave you advice that didn’t work out … but, really, who’s taking the time to dig up that old video that’s buried on a website somewhere?
To be fair, we don’t try and predict what the S&P 500 or NASDAQ will be priced at the end of the year, so this isn’t necessarily an apples-to-apples comparison. What we try to do is talk about what we see big picture – taking note of our concerns for the coming year as well as what we believe is the best positioning for the coming year.
With that said, let’s dig in…
2021 in Review
Last January we suggested that the best way to approach 2021 was by maintaining a proper asset allocation with a tactical shift toward small cap and international stocks. We viewed the bond market as more nuanced with the risk of higher rates making credit risk a safer bet than interest rate risk. We did think that the stock market would be higher, but certainly not 27% higher! If you have an interest in reading up on the specifics, you can find the 2021 Outlook here.
The balanced approach worked out well. Markets were up across the board with US stocks, once again, outperforming international equities. Our views for the bond market were on the mark as interest rates remained low and credit spreads tightened.
Looking back, it was extremely easy to be an investor these past 12 months for a number of reasons. First and foremost, the major US stock market benchmarks were all up double digits, with the S&P 500 up 26.9% as the Dow Jones Industrials Average (DJIA) added 18.7%. This comes as a result of a combination of record company earnings, a robust economy, and continued low interest rate environment.
Volatility was low. How low? So low that the S&P 500 not only ended the day on 70 occasions at new all-time highs, but these gains were spread out so that there was a new high every month of the year. This is something that has literally never happened. Without the usual periods of pain, 2021 was more of a steady glide upward.
Commodities (mostly) joined the party. The one that we feel the most, WTI Crude Oil, ended the year at $75.51/barrel for a 55.6% gain. Even the US Dollar posted a strong 6.3% return. The biggest losers for 2021 were the precious metals.
Overall, 2021 was a great year to be an investor.
2022 Outlook: Participate & Protect
“You can’t predict. You can prepare.” – Howard Marks
As easy as 2021 was in retrospect, we do not foresee a repeat performance in 2022. Coming off of the year of COVID there was massive amounts of stimulus from the government that really kickstarted the economy. With reopening came supply shortages and inflation, but also 5%+ real growth of the economy. The combination of stimulus and growth produced corporate earnings that were well above projections. Add on historically low interest rates and you had the makings of a monster stock market rally.
Underneath the surface of steady gains for investors there were some concerning issues for both the stock market and the bond market. For stocks, there was a real breakdown in many of the companies with little or no earnings that led in 2020. This is reminiscent of what happened in 2000 with technology stocks. Along with this, market multiples (the price investors are willing to pay for a dollar of earnings) enter 2022 at what can only be described as historically high. Again, reminiscent of 2000.
Moving to the bond markets, both yields and spreads are at or near historically low levels. This is concerning. This combination leaves bond investors open to lower bond prices as a result of higher interest rates, jittery markets that end up widening spreads, or a combination of the two.
We do find this to be a compelling reason to protect, but do not view it as a persuasive reason to batten down the hatches and load up on cash and gold. Truth be told, we believe there is never a good time to swing for the fences with a big bet either for or against the markets.
When one moves away from the noise surrounding the markets there is still a very compelling case for equities. The economy is projected to growth around 4% in 2022. While not 5%+, still very impressive and helpful to corporate earnings, which according to FactSet are projected to be around $222 on the S&P 500.
On the interest rate front, the expectation is for three increases in short term rates from The Federal Reserve. Given the track record since 2008 of promised rate increases not materializing, we remain skeptical about three increases in 2022. More likely, in our opinion, would be one or two ¼ percent rate increases spread out over the year. We see this as a positive for two reasons. First, coming off such extreme low interest rate levels, we expect the effect on stock market valuations to be minimal. As important, the stock market has historically continued to rise for 12-18 months after the initial rate increase! A more in-depth discussion on how interest rates affect the stock and bond market can be found here.
Ultimately, the stock market moves higher or lower based on two factors – earnings growth/earnings growth expectations and valuations (the market multiple the market willingly pays at any given time). Market multiples have been a very big part of the past 10 years of stock market growth here in the US. That growth, by the way, has far exceeded other developed markets. As measured by the S&P 500, the US stock market has grown 16% per year vs. 7.5% for MSCI All Country All World ex-US index. We should note that over that same 10-year time frame the inflation rate was 1.4%, meaning that the real return for the S&P 500 was 14.6%/yr!!!
Even as we expect a much harder investment environment going forward, all is not lost. In fact, we see 2022 as a year of change. We are of the opinion that the themes of the past decade won’t be those that propel the markets higher in the future.
Value outperforms growth (finally): Since the start of the current bull market in March 2009, value stocks have mostly underperformed their growth counterparts. In 2020 the limits were stretched to the point where we thought it would change – and it did! In 2021, however, a reversal happened with the end of lockdowns and the reopening of the economy. The reality of higher interest rates and a persistently high inflation rate favors companies with pricing power and more reasonable valuations. That, friends, are the value areas of the stock market.
Megatrends are Real: We are in a period of massive change and disruption. The large areas of growth won’t necessarily be in what many people consider “technology” today. Demographics and social change should change medicine and consumer habits. Climate change and resource scarcity should drive demand for a clean, green tomorrow. Emerging global wealth is changing how the global economy works. Some of the winners should be in traditional technology, but many will likely be in areas that may surprise. In our opinion, growth stocks in general may not be the best place for investment moving forward, but that doesn’t mean there is no room in a portfolio for companies that can grow their businesses exponentially.
Income Investing is a Huge Challenge: Which is something we have been saying for years now. The reason we look at bond allocations differently at the start of 2022 than we did in the past is because long-term returns do not necessarily determine what returns will be in the future, particularly with bonds. According to research at GMO Asset Management, between 1961 and 2021, “the average decade gave you a return of around 7.6% with a standard deviation of 2.9%. The last decade has seen just about the lowest return over the period, at 3.4% … Is a 7.6% return a fair expectation for future returns from 10-Year Treasuries?” (source) 10-year Treasuries over this time had an average yield of 6.0%, today that number is 1.4%. When you add in the fact that the Federal Reserve Board has indicated increasing short-term interest rates three times this year, caution is prudent.
US Dollar Strength Might Not Continue: The prevailing theory is that with the Federal Reserve starting to taper its bond purchases, and then increasing short-term interest rates later this year, there will be less “devaluation” of the dollar. The argument is that the dollar strength that happened in 2021 should continue. The bearish argument is that this does make sense on the surface, but doesn’t take into account the huge trade deficit we continue to run as a country. Based on that fact, the US Dollar should be lower – some would argue much lower – than it currently trades. We are in a wait and see mode right now with an eye toward a weaker dollar later on this year.
Putting it all together, Magellan Financial sees 2022 as a year with more volatility than occurred in 2021 but with modestly, positive gains for the stock market. The combination of market volatility and rising interest rates, will likely be a challenge for bonds. Investors can protect and participate by positioning via funds and individual stock positions that are overweight value with a portion of the equity allocated toward the megatrends. Allocating as such should help you avoid the most vulnerable areas of the market.
One great way to protect your assets is to have your bond portfolio act like a bond portfolio in poor or volatile markets. Taking on too much credit risk or interest rate exposure can leave you open to your bonds acting more like stocks during a market downturn.
In the end we all need to remember that investing is about the long game, not what happened between 9:30 am and 4 pm on any given weekday. We invest as a way of providing for life’s expenses, not for the sake of more, more, more.
As usual, these are strong opinions that are lightly held. If the markets change our opinions will change with them.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
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