“Lesson of the Century: The U.S. Economy Is Nothing if Not Resilient” – Barron’s
Magazine, December 27, 2021
We enjoy reading Barron’s magazine for its timely economic and investment information. During 2021, the magazine published periodic articles reflecting on its 100-year anniversary. A recent article was “Lesson of the Century: The U.S. Economy Is Nothing if Not Resilient.” Barron’s points out that on average, the Dow Jones Industrial Average has increased about 9% per year over the past 100 years despite many setbacks such as market crashes, recessions, depressions, wars, pandemics, and other unforeseen events. The Barron’s article notes, “When the Covid-ravaged economy contracted in 2020, it was just the 19th time since 1920 in which real gross domestic product had declined, year over year. And nine of those years came between 1930 and 1949, a result of the Great Depression or post-World War II demobilization.” A surprise to many investors in 2021 was the stock market continued to soar in the face of inflation worries and virus challenges. Large-cap stocks, small cap stocks, growth and value stocks all advanced strongly during the year.
For the full year, the S&P 500 Index achieved a total return of 28.7%, including dividends, while setting an astonishing 70 new highs during the year. This is the second highest annual total of record highs since 1995 when there were 77 recorded. The gain in the S&P 500 was the third largest annual gain over the past 20 years. The Dow Jones Industrial Average (DJIA) and NASDAQ also posted strong annual returns of 20.9% and 22.2%, respectively. Both indexes finished the year continuing their hot streak of five straight monthly gains for the DJIA and six consecutive monthly advances for the NASDAQ. All eleven sectors in the S&P 500 finished higher for the year. The best performing sectors during the year were Energy, Real Estate, and Technology while the laggards were Utilities, Consumer Staples, and Industrials. Several large cap stocks had a large influence on the robust annual gains in the S&P 500, notably Apple (up 33.8%), Microsoft (up 51.2%), Alphabet (up 65.3%), Home Depot (up 56.2%), and NVIDIA (up 125.3%).
The healthy returns of 2021 were accompanied by historically below average market volatility, thus alleviating some of the investor anxiety typically experienced during years with normal volatility. January, September, and November were the only months that recorded negative returns for the S&P 500, with only one instance of a 5% market decline from early September to early October. For comparison, over the past half century, the S&P 500 has undergone a 5% market decline on average about three times per year and a 10% decline typically once a year.
Strong corporate profits and easy monetary policy have fueled the strong stock market results over the past three years: 2019 – S&P up 31%, 2020 – S&P up 18%, and 2021 – S&P up 28%. In fact, corporate earnings in 2021 increased 45%, which was the largest increase in over a decade. But despite the strong market, the feeling among consumers was not altogether positive. The widely followed University of Michigan Consumer Sentiment Index fell to its lowest year end reading since 2008. The main reason for the lower sentiment reading is the general price inflation faced by consumers.
Based on the latest Consumer Price Index results released for December, inflation rose 7% over the past year, which was the largest increase since 1982. A key ingredient to the rising prices has been the sharp increase in the price of oil. U.S. crude oil prices climbed 55% to around $75 per barrel during the past year, which caused significant increases at the gas pump.
Currently, the S&P 500 trades at about 21 times projected earnings over the next 12 months, which is slightly above its five-year average of 19 times earnings according to FactSet. However, the multiple has decreased from 22.8 times at the end of 2020 with the strong corporate earnings generated during the past year. A key factor fueling the higher multiples has been the Federal Reserve’s accommodative monetary policy. But the Federal Reserve announced in November they would reduce their $120 billion a month in bond purchases to $90 billion in December. Then in December, the Federal Reserve announced they would further reduce their purchases by $30 billion a month starting in January, thus setting a pace to end this program in March.
Financial markets are faced with notable headwinds as we start 2022, including (1) the highest inflation levels since the early 1980’s, (2) a Federal Reserve that is expected to tighten monetary policy during the year, and (3) the unpredictability of the ongoing effects on the economy from Coronavirus.
One of the key variables that will determine the path for the stock market in 2022 will be inflation and how aggressively central banks around the world raise interest rates to mitigate inflation risks. Most economists expect inflation to remain high for at least the first half of 2022 before easing once the global supply chain issues return to a more normal level. However, many economists expect inflation to remain around 3% going forward which would mean the Federal Reserve would face the need for additional interest rate increases to achieve their stated average inflation target of 2% annually.
In mid-December, the Federal Reserve signaled they anticipate raising interest rates as early as March and approved plans to wind down their bond buying program more quickly. It is anticipated that the Federal Reserve will raise short-term interest rates 2-3 times during the year which would be the first time they have increased interest rates since 2018. Currently, the federal funds futures market is pricing in a greater than 50% chance of a rate hike at the March Fed meeting. Beyond this year, most forecasters expect the Federal Reserve to raise interest rates an additional three times in 2023. The impact of higher interest rates on equities is the present value of future cash flows declines, therefore negatively impacting the valuation assigned to securities. However, the benefit of rate increases would be seen in higher interest earnings on savings and money market accounts.
Concurrent with the expectation of rising interest rates, analysts expect corporate earnings growth, and overall economic growth, to moderate in 2022. Profits at U.S. companies are expected to grow, but at a slower pace than in 2021. CFRA estimates earnings per share for the S&P 500 will rise 7.4% in 2022 as compared to the 43% increase in 2021. Although forecasts vary from one firm to another on Wall Street, the U.S. economy is projected to grow anywhere from 2-4% during 2022.
One of the big positives for 2022 is the strength of the American consumer. Consumers have stronger balance sheets due to rising home values and the stock market growth over the last several years. Many consumers have also seen wages rise which should help keep consumer demand high and drive the overall economy. Consumer spending accounts for approximately 70% of Gross Domestic Product. Households have amassed over $1.6 trillion in excess savings according to the Federal Reserve Bank of New York since the pandemic began.
Another positive is that each new Coronavirus variant has had a smaller impact on the economy as we all learn to better cope with the virus. The economic impact of coronavirus has potential policy implications for the Federal Reserve. An increase in cases of Covid-19 could cause an economic slowdown, thus tamping down consumer demand and lessening price pressures. On the other hand, if the virus causes further global supply chain disruptions, the impact of a shortage in the supply of goods should cause upward pricing pressure. Therefore, the Fed will need to walk a fine line on monetary policy in light of Coronavirus economic implications.
Despite the headwinds faced by the economy, many forecasters on Wall Street believe the S&P 500 will rise in 2022. Wall Street firms such as Goldman Sachs, Wells Fargo, and Credit Suisse predict the S&P 500 will rise between 6% and 11%. The concluding paragraph in Barron’s sums up the resiliency of the American consumer and economy: “As Barron’s embarks on its second century, the U.S. economy shows little signs of slowing. It’s impossible to minimize the pandemic’s damage, with 800,000 deaths and Omicron causing new waves of cases. Yet, the economy seems to be shrugging it off, with today’s business leaders and workers finding a way to keep things running. The economy churns on.”
In November we welcomed the addition of Pierre Sorée as a Financial Advisor. Prior to joining Marietta Wealth, Pierre was a Wealth Manager at another fee-only firm in the Atlanta area. Pierre transitioned into the financial planning industry after a 17-year career at IBM in multiple roles including consulting, project management and contracts & negotiations – living and working across the U.S., in Europe and in Hong Kong.
Pierre earned a Bachelor of Science from the McIntire School of Commerce at the University of Virginia and his MBA from the University of Tennessee in Knoxville. He also completed the University of Georgia’s Executive Program for Financial Planning Certification in 2017 and is a CERTIFIED FINANCIAL PLANNER™ professional. Pierre resides in East Cobb with his wife, Meredith, twin sons (when home from college) and their two golden retrievers. In addition to enjoying quality time with family and friends, he enjoys outdoor activities including biking, running, tennis, golf, and kayaking. Pierre also completed his first Ironman triathlon in 2019.
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Marietta Wealth Management, LLC
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