The Weekend Edition #23 - Year End Special
The Year in Review vs The Year Ahead - Macro, Equities, Bonds & Commodities
Welcome to the Year-End issue of the Weekend Edition.
We’ve almost made it through 2021 and I want to congratulate each and every one of you for staying strong and getting through the year.
Thank you to all who’ve read and subscribed to the newsletter this year. I am very grateful and I hope we get through 2022 together.
Now, let’s grab a cup of coffee ☕️, while we take a look at what happened in the markets this week… and this year!
Here’s what we cover:
Market Recap - The week and the year
The Year in Review vs The Year Ahead - Macro, Equities, Bonds & Commodities
Closing Thoughts - Happy 2022!
Let’s dive in ⬇️
We had a shorter trading week as the markets were closed on Friday. I hope you and your loved ones had a wonderful Christmas.
Markets are up, the Vix is down and it would seem that the Santa Rally has begun, just in time for the year to end on a strong note. The S&P is very close to hitting Tom Lee’s 4800 target for the year… and we’re all cheering for him to be right. Well, most of us.
Because this is the last edition for the year, I’ve included the Yearly performance of each of the indicators above to compare. Markets have rallied nicely throughout the year, even with bond yields rising. Soft Commodities have rallied considerably as well, with Coffee taking the top position for the year, even more than energy. Imagine that!
We certainly can’t do without looking at the charts:
We’ve remained firmly above the 200-day moving average for the S&P (blue line), while testing the 50-day moving average about 9 times last year. This is a bit different from the Nasdaq Composite, as you can see below.
The Nasdaq has spent quite a bit more time during the year below the 50-day moving average, even coming quite close to the 200-day at the end of Sep.
While Big Tech excelled (we see this in the heat map below), Mid- to Small- Tech didn’t do all that well. Continuing into 2022, we will see pressure on these names… particularly those that don’t have earnings for the next few years. That’s not to say that they are bad companies but, rather became overpriced because of the liquidity euphoria we’ve experienced.
The Year in Review vs The Year Ahead
We’ve certainly had quite a bit of drama this year with the Fed, inflation, tapering and expiration of emergency stimulus packages. The liquidity in the market fueled the stock market and other interesting asset classes such as Cryptocurrencies and NFTs, if you can call them asset classes.
Home prices have increased to the highest they’ve been in the last 34 years (as far back as the data shows me). Fueled by the work-from-home situation, people started to move to the suburbs. Then came ample liquidity and cheap credit, so started the home buying. And now that millennials have a got a taste for the “home” life, sales are still growing, despite the rise in prices exacerbated by the supply shortages.
The US job market has recovered well but, there still remains a shortage of participation. The November US labor participation rate of 61.8%, is the lowest since 1976.
The Job Market has changed structurally due to the pandemic. With an aging population, some have decided to take early retirement, few have decided to stay back home and many have quit in the hopes that the gig-economy will provide them with the satisfaction they desire. The pandemic has caused a mental shift in people, who have come to realize that life is too short to be stuck in a job you hate.
We saw severe supply chain shortages play out with shipping delays and vessels stuck at ports like never before. We’ve seen companies navigate through these crises, some coming out as winners, while others suffering.
Inflation has taken it’s toll on companies and people. And the Fed refused to recognize it as anything but transitory until late November / early December. And now, policies will change and with that the markets.
2022 Outlook - Macro
We know what’s next:
The Fed increases the pace of tapering to end in March 2022 = lower levels of liquidity in the economy
Fed increases rates - the consensus is 3 hikes in 2022 - which takes the Fed Funds rate up to 0.75% to 1% (from 0% to 0.25% currently)
Inflation continues for at least two more quarters, driven by continued supply chain shortages.
Despite the policy changes, the pent up demand will continue to fuel inflation well into 2022, albeit at a decreasing rate. Even after the Fed hikes in 2022, the rates will still remain relatively low and accommodative. GDP is forecasted to increase at about 3.8% p.a. for the US in 2022 and 4%+ p.a. Globally. GDP growth has been 6%+ this year so, the consensus is for growth to slow in 2022.
While the US fiscal deficit continues, it has come down remarkably to -6% of GDP in 2021 compared to -12% of GDP in 2020. The fiscal deficit for the US now stands at around $1.48T. The consensus is that this should shrink to -4% in 2022.
A major factor in fiscal spending will be the Build Back Better program. While it remains to be seen what happens after the recent opposition, this program will create a massive need for fiscal funding.
As for housing, I don’t readily see people scrambling to move back to the cities. I think many will stay back in single-family homes - renting instead of buying.
Whatever the Macroeconomic environment has brought us, companies have still had a stellar year in 2021.
The level of operating earnings increased significantly in 2021 and with that came an increased level of buyback and dividends.
However, the percentage of earnings actually returned to shareholders has declined over 2021. Clearly companies are hoarding liquidity to manage unforeseen events. Given uncertainties may ease next year, it’s quite possible most of these companies choose to return more funds to shareholders rather than just hold them on the balance sheet.
Not surprisingly, the sector that took the top position during the year was Energy. Real Estate on the other hand is a bit of surprise as it made it’s way quietly up through the ranks during the year. As for technology, I suspect much of these gains came from the Big Tech companies, who as you can see above outperformed significantly.
2022 Outlook - Equities
Equities should still do well. For one, there’s no alternative to stocks but also when you look at the basics, companies have done really well to navigate through the inflationary environment and will continue to do so. JPMorgan’s estimate for the S&P is 5050.
Sure, with decreasing liquidity from the tapering cycle we probably won’t see the outsized capital gains that we’ve been seeing over the last two years but, that doesn't mean you won’t see gains anywhere. We just have to be more careful with the type of company we pick.
Dividend stocks will probably become popular again as investors look for income sources to offset lower capital gains. The structural changes to the working population - more retirees & family members staying home - will also mean investors will look for a stable source of income.
3 sectors of interest for 2022 will be:
REITs, as inflation continues and because they pay decent dividends
Financials, as they do well in times of rising rates, particularly the smaller banks who derive more of their income from interest-bearing loans
Healthcare, as these companies have strong balance sheets and surprisingly, pent up demand. Covid-19 made basic healthcare essential but, put the brakes on the broader healthcare industry.
We will look at strong companies, with solid cash flows. The FAANGs + Tesla is the obvious choice for everyone. While they certainly are top notch, and hold up the market much of the time, I still see plenty of other choices and not in tech.
I think earnings will remain considerably strong for most companies for a while as GDP continues to grow and the economy returns to normal.
Here’s a chart of Corporate Cash Flows, which remain stronger than ever. ⬇️
Bond yields have been on a steady climb throughout the year. Shorter term yields have seen a steeper rise compared to longer term yields, causing the yield curve to flatten quite a bit.
2022 Outlook: Bonds
The consensus is that bonds will be out of favor in 2022 as yields rise and bond prices drop. Most portfolio managers are looking to allocate to US Corporate Bonds of high quality, but it certainly won’t be “overweight”.
The increase in energy prices led the commodity sector as a whole but, soft commodities weren’t far behind. There has been a reversal in agriculture prices and if you look at the last 13 years prior to 2021, agri commodities had been a long-term down trend.
2022 Outlook - Commodities
Shortages of workers, supply chain disruptions and weather anomalies have combined to push agri prices higher. Food inflation is not going away next year and while prices may ease somewhat, they’re not heading back down drastically.
Most experts are still bullish on energy and commodities in general. However, precious metals (gold & silver) have a bearish outlook. They’ve underperformed in 2021 and most experts expect this to continue into 2022.
And finally, a few stats on IPOs from Renaissance Capital. 2021 was a massive year for listings, with 399 companies raising $142.5B. It was the biggest year for IPOs in the past 20 years.
The largest IPO was Rivian, the electric truck-maker, raising $12B. A few notable listings for 2021:
Closing Thoughts - Happy 2022!
A couple of weeks ago, I wrote a note on Commonstock titled “We’re Not Closing the Stock Market”. And that’s the message… for today, next year and the foreseeable future.
Tapering asset purchases and rate hikes don’t necessarily mean gloom and doom for the stock market and this chart below was exactly the one I was looking for to drive this point home.
The S&P returns turned negative after 9 rate hikes - so we have some ways to go. And even after that the market prospered in 2019 with Fed Funds at the 2.5% mark.
Don’t forget, the economy is also recovering from an unprecedented event and it’s doubtful that the Fed will be too aggressive with rate hikes, risking an inverted yield curve and possible recession.
Having said that, navigating the stock markets next year will probably require a little more thought and a bit more discipline. Things are about to get slightly more challenging but, there’s no reason to panic… and there’s definitely no reason to panic buy or panic sell.
I think next year will be a time for more careful stock picking instead of sector or style rotation. While there’s some consensus on which sectors will do well, I think 2022 will be a year we go back to basics and pick stocks based on strong fundamentals. We will still keep an eye on the markets, and sectors but identifying strength will be key. We will need to hold our picks to much higher standards.
Here’s wishing you a happy weekend and safe investing during the last trading week… and Happy New Year!
Ayesha Tariq, CFA
There’s always a story behind the numbers
None of the above is Investment Advice and all views are personal. I may or may not have positions in any of the stocks mentioned. I have no affiliation with any of the companies that are mentioned.