2021 – The Second Act of a Drama that Began in 2020
It would seem to be counterproductive to look at these past 12 months in isolation. They were, rather, the second act of a drama that began early in 2020, the precipitant of which was the greatest global public health crisis in a hundred years.
The world’s governments chose to respond to the onset of the pandemic by shutting down the global economy—placing it in a kind of medically induced coma. In this country, we experienced the fastest economic recession ever, and a one-third decline in the S&P 500 in just 33 days.
Congress and the Federal Reserve Bank responded all but immediately with a wave of fiscal and monetary stimulus which was without historical precedent. This point cannot be overstressed: we are amid a fiscal and particularly a monetary experiment which has no direct antecedents.
This renders all economic forecasting—and all investment policy based on such forecasts—hugely speculative. I infer from this that if there were ever a time to just put our heads down and work our investment and financial plan—ignoring the noise—this is surely it.
A Banner Year and A New Year
The year 2021 was a banner year for investors. The broad-based S&P 500 Index, which is made up of 500 larger U.S. companies, finished the year up +26.9%. If we included reinvested dividends, the index advanced +28.7%, according to S&P Dow Jones Indices.
Much better-than-expected corporate profits (Refinitiv), which were powered by an expanding economy, plus a super easy monetary policy from the Federal Reserve, deserve much of the credit.
Low interest rates, low bond yields, and rising profits easily offset worries about the lingering pandemic and much higher-than-expected inflation.
But we are now looking ahead into 2022. What might the new year bring? After last year’s strong advance, what might be in store for this year?
Since 1950, there have been 26 years in which the total annual return of the S&P 500 Index exceeded +20%, according to data provided by the NYU Stern School of Business. In the following year, the S&P 500 Index advanced 20 times, or +77% of the time, in line with the long-term average.
The average up year was +18.1%, while the average down year was -6.4%.
It’s an interesting exercise, but let’s always remember that past performance is no guarantee of future performance. Each year will have its own distinctions.
We could add one more wrinkle. The total return of the index has doubled over the last three years, according to Dow Jones Indices.
The Biggest Forecasting Error in the
107-Year History of The Fed
Federal Reserve (FED) Chairman Jerome Powell said last week that the economy is both healthy enough and in need of tighter monetary policy.
That likely will entail interest rate hikes, tapering of monthly asset purchases and a smaller (FED) balance sheet. (Instead of buying trillions of bonds injecting trillions into the money supply, the Fed will be selling bonds to the banks thereby reducing the supply of money).
Powell made the comments during a confirmation hearing in which key senators indicated they will be supporting him for a second term.
We then heard from four of the Federal Reserve Open Market Committee (FOMC) members who told us to expect four rate increases starting in March.
At the beginning of 2021, the Fed expected no rate hikes in 2022. One-year ago inflation was just +1.4%. Last week we learned inflation is now +7%. What Fed forecasts came remotely close to predicting this? NONE.
This is about the biggest forecasting error in the 107-year history of the Fed. And last week the bond market’s response was epic. The 30-year US T-Bond data goes back to 1973. It was the worst calendar week total return in at least 49-years of history! The long bond lost -9.4%!! If this was a year, a -9.4% total return loss would be the 5th worst year ever.
Fixed income is no longer a safe investment. With interests so low, higher rates will lead to capital losses. Last week’s loss was -9.4%.
Inflation (CPI) is way ahead of the market (10-Year Yield).
If 2020 was the year of the virus, 2021 was the year of the vaccines. Vaccination as well as acquired natural immunity are in the ascendancy, regardless of how many more Greek-letter variants are discovered and trumpeted to the skies as the new apocalypse. This fact, it seems to me, is the key to a coherent view of 2022. In general, I think it most likely that in the coming year:
- the lethality of the virus continues to wane,
- the world economy continues to reopen,
- corporate earnings continue to advance,
- the Federal Reserve begins draining excess liquidity from the banking system, with some resultant increase in interest rates,
- inflation subsides somewhat, and
- barring some other exogenous variable—which we can never really do—stock values continue to advance, though at something less (and probably a lot less) than the blazing pace at which they’ve been soaring since the market trough of March 2020.
Please don’t mistake this for a forecast. All I said, and now say again, is that these outcomes seem to me more likely than not. I’m fully prepared to be wrong on any or all the above points; when I am, my recommendations to you will be unaffected, since our investment policy is driven entirely by the plan we’ve made, and not at all by current events.
With that out of the way, allow me to offer a more personal observation. To wit: these have undoubtedly been the two most shocking and terrifying years for investors since the Global Financial Crisis of 2008-09—first the outbreak of the pandemic, next the bitterly partisan election, then the pandemic’s second major wave, and most recently a 40-year inflation spike.
You might not be human if you haven’t experienced serious volatility fatigue at some point. I know I have.
But like that earlier episode, what came to matter most was not what the economy or the markets did, but what the investor himself/herself did. If the investor fled the stock market during either crisis—or, heaven forbid, both—his/her investment results seem unlikely ever to have recovered. If on the other hand he/she kept acting on a long-term plan rather than reacting to current events, positive outcomes followed. It was ever thus. I expect it always will be.
Very truly yours,
Sources: Historical S&P 500 Index and dividends: “S&P 500 Earnings History, NYU Stern School.” Consensus 2021 earnings forecast: Yardeni Research. Consensus 2021 dividend forecast: Bloomberg. Consumer Price Index: Inflationdata.com. Current net profit margin of the S&P 500: FactSet.
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