2021 ended with the S&P 500 up nearly 27% and the NASDAQ up 21%. Year to date, US Large Cap Growth outperformed Value by almost 10%. For a year marked by uncertainty, the market produced fantastic returns. Looking back, the S&P was up 16% in 2020 and over 28% in 2019. That’s three years of impressive returns in a strikingly unprecedented time. And 2022 continues to be unprecedented: rising inflation, a slowing economy, and the beginning of the end of quantitative easing. Multiples in certain stocks are reminiscent of the dot com bubble, and we continue to feel the effects of COVID lockdowns and a diminished labor force. It’s true the market is flashing some warning signs, but we see strategic opportunities for equities in 2022.
Despite inflation, the US consumer is coming into 2022 in a healthy spot. Savings are high and there is pent up demand for goods and services. Spending on goods far outpaced services in 2021, despite global bottlenecks that stubbornly continue into 2022. As COVID 19 variants appear and spread, service spending will be muted by travel restrictions and lockdowns until there is a reliable response to COVID 19. So far that has not come in the form of a vaccine, but there is hope that between medication and more targeted vaccine boosters, COVID may fade into the same category as the yearly flu. However, the timeframe remains questionable, and the emergence of a severe variant remains a risk.
Uncertainty and risk persist in equity markets, with the aforementioned COVID, elevated stock valuations, and rising inflation. While no doubt a challenging backdrop, we continue to favor equities over bonds and have positioned our models to take advantage of opportunities in the equity market. It’s becoming clear certain Growth names have become overvalued, namely within the Communications and Technology sectors. While not completely bearish on all Growth names, we’ve begun to favor Large Cap Value and have recently moved profits in the Growth sector to the Value sector. Financials are the largest percentage of US LC Value sector. They stand to benefit from rising rates and remain reasonably priced. Energy has performed well and along with Materials, stands to benefit from an increasing demand for commodities due to inflation. Industrials are poised to benefit from a weaker US dollar, an infrastructure plan, and the eventual economic reopening post COVID. Additionally, Value names tend to provide more protection during market downturns than Core or Growth, and should provide less volatility during market corrections.
Historically, markets thrive during quantitative easing, but struggle under quantitative tightening, which is where the Fed is headed in 2022. In order to combat inflation, the Fed plans to taper bond buying and raise rates. Most agree the Fed is already behind, with inflation far outpacing the Fed’s mandate and “transitory” no longer an acceptable adjective. The possibility of 3 rate hikes loom this year, and bond buying could be wrapped up in Q1. Considering the rising rate environment, our fixed income positioning has focused on low duration and high quality. We’ve added investment grade corporates to the asset mix, while keeping duration low to protect against rising rates. Considering the challenging and low yielding fixed income environment, fixed income should be considered more for principal protection over income generation.
While 2022 may not bring the same level of market return the past three years have provided, we are skeptical of the large-scale crash you’ll see predicted in some headlines. However, market corrections are a possibility. In today’s challenging environment, tactical weighting and active management can provide opportunities. Our Wealth team believes your personal goals and investment horizons should be evident in your portfolio, and we’re prepared to help you in 2022 and beyond.
Heather A. Voight, AIF® | Portfolio Manager
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