Windsor Perspective: Q1 2022
Happy 2022! It is hard to believe another year has passed and we are now in 2022. All of us at Windsor Wealth Management want to wish you and your families a very happy new year and to thank you for your trust in us this past year. We look forward to working closely with you and your family in 2022 and beyond.
In this edition of the Windsor Perspective, we review the market performance for 2021. In addition, we discuss our initial thoughts on the market as we enter 2022.
Q4 and 2021 - A double whammy!
2021 ended on a very strong note, with the S&P 500 delivering a total return of 11.02% in the fourth quarter of the year.
S&P 500 Index Q4 2021
Source: Bloomberg, Windsor Wealth Management
The market did experience mild volatility in the back half of the quarter. This volatility was driven by two specific items: the emergence of the Omicron variant of Covid-19 and the Federal Reserve becoming more aggressive to counter the rise in inflation. Fortunately, the market was able to shake off these concerns and regain momentum in the final weeks of the quarter.
This strong close to the fourth quarter resulted in a very strong return for the year. For the full year of 2021, the S&P 500 delivered a 28.71% total return, finishing the year just off the all-time high set on December 27th. A very impressive year indeed.
S&P 500 Index 1-year
Source: Bloomberg, Windsor Wealth Management
The performance for 2021 ranked as the 21st best year for the index since 1926. This was also the 36th time since then that the market has delivered a total return more than 20% in a calendar year.
Greater Than 20% Return Years for the S&P 500
More importantly, in the year following a +20% return, the S&P 500 on average has returned 11.3%, with 69% of the readings being positive.
Annual Performance Following a 20% Gain or More in the Prior Year
Source: Strategas, Windsor Wealth Management
Despite this strong performance, the year was unusually mild in terms of pull backs. In 2021 the S&P 500 experienced the fourth smallest drawdown since 1987. Although we would typically expect to see pullbacks of 10% or more in any given year, the largest drawdown in 2021 was just -5.2%.
S&P 500 Largest Intra-Year Drawdowns
There are a few more interesting facts about 2021 worth sharing. The S&P 500 set 70 new highs in 2021, the second-best year for new highs, only second to 1995. This was the fifth year in a row where large cap outperformed small cap. This is only the second time since 2011 that the S&P 500 has outperformed the NASDAQ. The 3-year price return of the S&P 500 is 90.13%, the highest level since 1999. And last, despite all the market concerns, the yield curve as measured by the spread between the 2-year and 10-year treasuries, ended the year roughly right where it started the year. An interesting year indeed.
2022 - Our initial outlook
As we enter 2022, there are many headwinds the economy is facing. At the same time, there are many positives providing tail winds. This combination of forces could lead to short term challenges that ultimately results in gains for the full year 2022. As we begin the year, we are in the eye of the storm with the Omicron variant of Covid-19. It appears January may be the climax for this wave, but the ramifications to the economy are unknown at this time. From tens of thousands of airline cancellations, employee shortages at restaurants and retailers, to a return to work from home, this strain of the virus is having ripple effects through the economy. However, this variant also appears to be much milder and should run its course much more rapidly than previous variants. The stock market has already begun to look through this wave, but we would expect potential volatility near term on news reports and unknowns, both good and bad, from the virus. Other risks to 2022 include inflation, labor shortages, continued supply chain issues, Fed policy, fiscal policy, and potential military conflicts. On the positive side, there continues to be very strong pent-up demand from both consumers and businesses. This should help propel operating earnings in 2022. Employment remains strong as does manufacturing and output. Inflation will continue to be an issue, but we remain confident that inflation is transitory but will reset at a higher more “normalized” level as this inflation is mean reverting, not uncontrollable inflation.
Inflation: After Years of "Undershooting" Inflation in Normalizing
This current bout of inflation is being driven largely by goods shortages (i.e. supply chain related shortages). When you break down what categories within the CPI are driving the growth in inflation, there are five categories that are accounting for 75% of the incremental growth in inflation the past 12 months. These categories are new cars, used cars, household furnishings and supplies, apparel, and recreation services. As the supply chains resolve themselves, good prices should moderate and help relieve the inflation spike we are experiencing.
Also, interest rates remain very low, resulting in very low yields for fixed income investors. Equities continue to be the vehicle of choice as 45% of stocks have dividend yields greater than the 10-year treasury yield. If inflation remains above 3% (which is a reasonable, normalized range), fixed income will continue to face headwinds.
% of S&P 500 Stocks with Dividend Yields Greater
Than the 10-Year U.S. Treasury Yield
In addition, we may be facing a negative real rate (10-yr Treasury less inflation) environment depending on where inflation settles out. Historically, stock markets perform well in negative real rate environments. The reason for this is corporate earnings are a function of revenue growth which benefits from inflation. The cost of capital is driven by the 10-year treasury. Thus, if the cost of capital is low while revenue is growing rapidly, that typically drives stock prices higher.
Realized Real Rates vs Stock Market Performance
Stock Returns Good with Negative Real Rates
Another positive is that 2022 is a mid-term election year. Historically the stock market reacts positively during these years. Post 1938 (prior to 1938 there was really no market movement) there have been significantly more positive mid-term election years than negative years. In addition, there were only two very poor years, but both of those were right before the economy entered a recession and thus are not relevant comparisons for today.
Stock Market Performance in Mid-Term Years
Finally, the economy is going to go through a rotation from fiscal to private demand. The government spent historic sums to support the economy during the pandemic and its withdrawal will create a large “fiscal cliff” in 2022.
However, the markets have been anticipating this and pricing it into valuations. More importantly, consumers have saved between $2-$3 trillion during this time period. The liquidity that has been placed into consumers bank accounts is extraordinary. In addition, corporations have earned significant profits and will also be reinvesting into their businesses. Jobs remain plentiful, wages continue to increase, and the consumer wants to spend. This pent-up demand for goods and services from both the consumer and corporations will be a driving force into 2022.
$Tn, Rolling 4-Quarter Spending Potential in Excess of Consumption
Source: J.P. Morgan
It is very early in 2022 and a lot can happen between now and year end. The cross winds mentioned above appear more near term and mainly carry over from 2021. This may result in more volatility in the first half of the year as the market sorts through all the puzzle pieces. But once the edges of the puzzle are sorted out and connected, we believe the economy will be set to continue growing through the year as the puzzle comes together. Nearly all indicators point to a strong economy as we enter 2022.
As always, we will be seeking out opportunities for your overall financial plan based on the current economy and our outlook. Together, we will continue to tailor your plan to suit your unique financial objectives and a risk level you are comfortable with. Thank you for your confidence in our team and in Windsor Wealth Management.
If you would like to talk about any of the issues raised in this edition of Windsor Perspective, or any aspect of your financial plan, please contact us.