Got to kick off the week last year by having a birthday for my son Evan. He’s 22. Really easy to remember his age, just need to look at the year. He’s into his final semester of college, and wants to pursue a career in Insurance. He’s currently doing his Chartered Life Underwriter designation, which as anyone who has ever attempted it knows, is pretty tough. Happy Birthday mate!!! Very proud of you…
Ok I sent you the returns last week, which was my lazy way of not having to write an article. However, this information, albeit lazy on my behalf, is very important. It’s not the number that’s important, it’s how you compared to the number. We’ve created a new graph that I will update each quarter to give you some insight into not only the market, but the segments of the market. Last year showed some interesting divergence between the different size and style areas, as well as the sectors.
Much to my dismay, small caps were massive under-performers last year. The S&P 500 nearly doubled the 14.8% that small cap stocks squeaked out. There were only 4 of 11 sectors that beat the overall S&P 500, which shows how narrow the returns of last year’s market were.
As you know from reading and listening to me over the past year, I expected small caps to outperform larger stocks. It’s one of the commonly accepted data points coming out of a recession, small cap companies tend to outperform. That theory worked from about October of 2020 to around March of last year, then small caps (as identified by the Russell 2000) stalled and have been basically flat since. While the S&P 500 (Large Cap stock index), continued to rally.
Things move much quicker today than they did before. It all makes sense given how much computer trading influences short term movements and the amount of excess liquidity is in the market. You need to be on your game to capture their moves. Don’t be concerned, this is the exciting part!
So, let’s look ahead to this year’s landscape, areas of concern and opportunities.
The first few days of 2022 have seen a MASSIVE move in the 10-year treasury yield. December 3rd of last year had the U.S. 10-year treasury yield at 1.35%, and now at the time of writing is sitting around 1.74%. A 30% move in a month. This has several effects on markets, but here are a few:
- Trying to get a return in the bond market becomes extremely difficult. Remember that when rates rise the price of your bond goes down. No one wants your 1.35% bond if they can but a 1.74% bond. This is only a huge issue if you need to sell your bond, or you’re stuck in a bond mutual fund.
- As the yield curve steepens, banks make more money. Remember banks borrow short term and loan long term. The difference between these rates is profit to the banks.
- Stocks and/or sectors of the market that historically have high dividends (such as utilities) tend to get crushed when rates rise. The predominant thought being that if I can switch to the bond market to get the same yield, do so.
- Value stocks tend to outperform when rates rise. Value is identified by stocks that have solid fundamentals, can show consistent profits and/or have lower price to earnings ratios (P/Es). As opposed to growth stocks who have higher P/Es.
- Rates going up is generally good for stock market returns, despite what the talking heads will tell you. You generally just see a change in leadership.
See the chart below. I zoomed in on the time period between August 14 of 2020 and March of 2021, when the 10-year made its last rally.
This turn in events is exciting for me. As the shift moves away from chasing returns from companies that have a prospect of making money in the future, to companies that actually make money now. Fundamentals I like. Fundamentals I understand. Fundamentals is what it comes back to, well…eventually.
The other exciting part is these environments, it can provide a reward to sector and stock selection. Many financial advisors out there are buying mutual funds and/or ETFs, and become very passive with their investments. Passive I classify as buying an index fund and then reporting on how that manger performed. When markets rally like they have in the past year, things can trade up with no fundamental reason. That can’t be sustained forever.
Here are my predictions for 2022:
A positive year for the stock market, albeit with much smaller returns than last year. I have the S&P 500 ending the year at 4830, which is a meager 3% return. Remember that’s for the overall market, there will be bright spots within the sectors and individual securities. Also remember we still have, and are still increasing the stimulus in the economy. The current tapering going on means the fed is buying less bonds every month, not selling them (or withdrawing liquidity).
My estimate is based on a 21 multiple, (that’s the amount of times you pay for earnings). Last year’s multiple will likely be somewhere around 23.1. The 25-year average is around 19.
So why not pull your money out and keep it under the mattress? Well, first I could be wrong. I like to think unlikely, but possible. 😊 Earnings could come in better than I expect. They did last year. The Fed will have an impact next year. It will be short lived, whatever it is, but it’s likely they will either raise rates too quick or too slow, which will spook the markets, and lastly who knows what type of freaky news will hit us.
Good news is that as I sit here today, I don’t see any investment we are in that I would classify as “Euphoric”. We have a whole new asset class now that has taken a lot of the speculative money out of the market. That leaves the path clear for higher highs. When I make these estimates, I’m trying to be conservative. So, with all that, here’s the Buy/Sell.
Mick Graham, CPM®, AIF®
Branch Manager Raymond James
Financial Advisor Melbourne, FL
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