Dear Clients and Friends,
2021 was a banner year for equities, as enormous fiscal and monetary stimulus through the pandemic supported the strongest economic and earnings growth in decades during the reopening. The S&P 500 Index experienced minimal volatility while returning 28.71% (largest intra-year pullback being just 5.2%), though there was plenty of action beneath the surface. In addition to the rollout of vaccines, markets were supported by several other positive developments, including strong corporate earnings and increased consumer demand. In the third quarter, US corporations pulled in record profits—both in dollar terms and as a share of GDP (11%).1 That came as consumer spending generally trended higher throughout the year, rebounding from pandemic lows. As we transition into 2022, we remain positive on equity markets but believe the pace of market growth should be moderate and normal periods of volatility will return as Fed policy normalizes, along with the rate of economic and earnings growth.
Though the markets had a strong year, the recovery was accompanied by labor shortages, supply chain issues, and rising inflation. Prices increased especially rapidly in areas such as food and energy, and the US consumer price index jumped 6.81% from year-earlier levels in November, an increase we haven’t seen in nearly four decades. The media was filled with debates about where inflation would go, what was causing it, how long it might last, and what could, or should, be done in response. I think I heard the word “transitory” more in 2021 than I did in all my previous years on this earth.
For investors worried about the impact of inflation on their portfolios, it is important to remember that US stocks since 1991 have generally provided returns that outpaced inflation. This is a valuable reminder for those concerned that today’s rising prices will make it harder to reach long-term financial goals. As seen in Exhibit 2 below2, equity performance in the past three decades does not show any reliable connection between periods of high (or low) inflation and US large cap stock returns. The weakest returns can occur when inflation is low, and 23 of the past 30 full years saw positive returns even after adjusting for the impact of inflation.
The Fed’s view was that inflation pressures would likely be transitory, meaning not permanent. However, the rise in inflation expectations, continued supply chain strains, wage pressures, and the broadening of price increases is a worrisome combination. The Fed recognizes the risk of a more persistent increase in inflation. The Fed began to reduce (‘taper’) its pace of asset purchases in November, lowering purchases of Treasury securities and mortgage-backed securities by $15 billion each month, but will accelerate that pace in January3. The plan as it stands is for them to take purchases down to zero in March of 2022. The FED’s quantitative easing was an important tool during the pandemic, but the economic recovery no longer needs that much support. We believe this is a necessary step but feel this could impact market volatility. The FED will be walking a fine line between letting up on the throttle while hoping not to shock the economy. We think this will be hard to get perfect.
The markets are coming off a strong 3-year period. Because of this, we cautioned our clients that (some) mutual funds were going to have substantial capital gain distributions paid out to its investors at year-end. This was less of an issue in recent years; in 2019 we were coming off a negative 2018 that had losses on the books, offsetting gains made in 2019. In 2020, there was volatility in February – March that created losses which helped offset gains later in the year. With the elevated cash balances from these payouts, we are using this opportunity to rebalance client portfolio’s which you may have seen (and will continue to see) in the coming months. We will be adding to any fixed income positions that are underweight, ensuring your fixed income allocation matches your future spending needs and current risk tolerance. Additionally, we have seen strong US stock outperformance over the past decade, but more recently again in 2021. This has caused our client’s US stock allocation to be greater than the target, so we plan to rebalance those holdings in favor of adding to International holdings that we believe have value.
Last year was a year of reaching new highs. The S&P 500 notched 75 closing records in 2021 on a total return basis2. But, reaching a new high doesn’t mean the market will retreat the following year. Stocks, at any time, are priced to deliver a positive expected return for investors, so reaching record highs regularly is the outcome one would expect.
This is a good reminder of the power of markets. Investors can’t predict the nature or timing of the next crisis, or the end of any existing ones. But markets are forward-looking and reflect optimism. New challenges will await, but rather than guessing at what will happen, investors can choose to trust markets and their long-term prospects. The year 2021 emphasized the benefits of discipline, diversification, planning and perseverance in an uncertain market (like markets in all the years before it). As we enter 2022, looking backward can help as investors look to the future.
If you would like to discuss your long-term financial plan in greater detail or would value a review of your current investments, please contact our office to schedule time with one of our Wealth Advisors. If you are not currently a client and value a second opinion, we are here to help. Now is a better time than ever to look at your current investments and financial plan to make sure they are properly positioned for the unexpected.
Disclosures: The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur. Past performance does not guarantee future results. The information provided is for educational and illustrative purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. Vance Wealth, Inc. (“Vance Wealth”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Vance Wealth and its representatives are properly licensed or exempt from licensure. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index.
- Data is based on after-tax corporate profits from current production and is according to estimates from the US Bureau of Economic
- Dimensional Funds – Market Review 2021: A Recovery Amid Challenges, January 5, 2022
- Raymond James Investment Strategy Quarterly – Volume 14, Issue 1, January, 2022, 2022 Economic Outlook: Turbulence Ahead – Dr. Scott J. Brown, Chief Economist, Raymond James