January 2022 Investment Commentary

In each Glen Eagle Investment Commentary, we like to use parables, stories, and metaphors to help explain our thoughts about the market. As we looked back on this past year and analyzed what 2022 could bring, we were inclined to go back to one of our childhood favorites….Goldilocks and the Three Bears.

After tasting our share of hardship in 2019 with the pandemic, oil crash, and Brexit, we, as investors, finally got to experience our Goldilocks-moment as the environment became “just right” for stocks to grow in 2020 and 2021. Specifically, the Federal Reserve and Congress started pumping billions of dollars into the economy each month while simultaneously dropping interest rates to near-zero levels. As a result, we experienced two consecutive years of immense growth with the S&P 500 increasing 16.3% and 26.9% in 2020 and 2021, respectively.

Yet as we look forward to 2022, there seems to be a growing divide between these recent stock market returns and the emotional state of many Americans. For example, the University of Michigan recently published its consumer sentiment index, which dropped to its lowest level since 2008. (1) While it may seem counterintuitive that Americans are growing more pessimistic about their future just after the stock market has hit all-time highs, it actually aligns with some of the data we have seen:

  • Unequal Stock Market Gains: While media outlets have cited the high stock market return, few of them have mentioned how concentrated that gain was. Microsoft, Nvidia, Apple, Alphabet, and Tesla accounted for one-third of the market’s gains in 2021 and more than half of its gains since last April. (2) That means that 1% of all the companies in the S&P 500 were driving its movements.

  • Covid Cases Rising Again: With the surge of Covid’s Omicron variant, the US is now averaging more than 580,000 new infections and more than 1,200 deaths every day. (3) Needless to say, this has more than tampered the hopes that many Americans had for a full reopening.

  • Real Wages Falling: Inflation has been rising as the prices of everything from gas to food continue to spike. As a result, the real disposable income of the average American is now lower than even before the pandemic, (4) and one in four consumers are reporting inflationary reductions in their living standards.(5)

  • Government Support Ending: The child-tax credit payments, which gave many American parents $3,000-$3,600 per child, ended this past month. Additionally, at the end of April, the government will once again require individuals to pay the interest of their federal student loans, something that has been optional since the Covid crisis began. Together, these two developments will remove roughly $25 billion dollars out of the economy each month. (6)

All these above-listed points, which have helped to create the current level of pessimism we see in consumers, are concerning. They are not, however, the main catalysts that investors need to watch going into 2022. To put it differently, the three Bears that could disrupt us from our dream of yet another year of high double-digit stock market growth are still out there. They will soon arrive, and understanding who they are will help intelligent investors shape their portfolios and manage their expectations:

  • The Great Big Bear – Rising Interest Rates: The Federal Reserve now finds itself in a difficult situation as it tries to implement policies that will tamper the highest level of inflation the country has seen in four decades. The most obvious means of doing so is by raising interest rates.
  • Investment Implications: The bond market will continue to underperform in 2022. This is because 66% of all global bonds have yields of less than 2%. (7) Investors don’t like to hold onto such low-yielding assets when inflation is high and interest rates are rising. Conservative fixed-income investors need to shift their exposure to short-duration bonds (1-3 years) so that the negative effect of rising interest rates is mitigated.

  • The Middle-Sized Bear – Tech Overconcentration: The largest technology companies have continued to get bigger for the past several decades. Apple illustrates this phenomenon well. Apple was founded in 1976 and it took the company 44 years to hit a market cap of $1 trillion (in 2018). Two years later, the company was worth $2 trillion (in 2020), and now, a mere 16 months later, the stock is close to reaching a $3 trillion valuation. (8) As a result of this type of exponential growth, technology companies have gone from composing around 25% of the S&P 500 in 2017 to roughly 40% today. (9)
  • Investment Implications: Due to the high valuations that many companies have achieved during the pandemic, investors are starting to look more critically at what they invest in. We have already started to see this change in investor preference with high-growth companies like Peloton, which has fallen more than 80% from its high point. Seeing as the technology sector has a higher proportion of these types of high-growth, low-profit companies within it, we expect to see this sector lag in performance compared to other areas of the market in 2022.

  • The Little Wee Bear – Corporate Earnings Slowdown: Over the past year, many companies in the S&P 500 reported earnings growth of over 50%. This astounding growth rate, however, was largely a result of the fact that these companies were comparing their earnings to the previous year when earnings were artificially low during the pandemic. This helpful effect will disappear in 2022, leading companies to report much lower earnings growth rates.
  • Investment Implications: Companies can mitigate the negative effect of this earnings slowdown on their stock price by leveraging their excess cash. Companies that can return cash back to their shareholders through dividends or stock repurchases will do comparatively better than those that fail to do so. Additionally, many companies can make acquisitions to boost their earnings. It is critical, however, that any such acquisition fits within the company’s existing business strategy and that the company avoids the trap of overpaying for the business. One only has to think of when Quaker Oats acquired Snapple for $1.7 billion in 1994 only to sell it two years later for just $300 million to understand how impactful bad acquisitions can be.

As we conclude our newsletter, we want to emphasize that our above comments should not be misinterpreted as an indication that the stock market is headed toward a recession. Rather, we want our version of “Goldilocks and the Three Bears” to highlight the fact that we are now entering into a new market environment, and in this new environment, investors will need to adjust their expectations for what the stock market can reasonably return going forward. The 20% plus growth rate we witnessed last year should be viewed as an anomaly, and prudent investors should plan for lower annualized returns going forward that are much closer to historical norms.

As we enter 2022, we want to wish you a healthy, happy, and prosperous year!
 
The Michel Team
Susan, Rob, and Carol Ann
 
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC, and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation, or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.

(1) Barrons – The Stock Market Had a Wonderful Year. Too Bad No One Enjoyed It (2)WSJ – Five Big Tech Stocks Are Driving Markets. That Worries Some Investors (3) Bloomberg Evening Briefing “More fuel for rate hikes” (4) Apollo Chief Economist “More inflation and less fiscal policy” (5) Reuters – US Workers Quitting Reaches Record High, Job Openings Edge Down in September (6) Barrons - The Fed Could Be Shifting Gears at Just the Wrong Time (7) Apollo Chief Economist “Two-thirds of bonds in the world yield less than 2%” (8) Barrons - Apple's Market Cap Is Heading to $3 Trillion. That's Just the Warm-Up (9) Apollo Chief Economist “S&P500 behaving more and more like Nasdaq”
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