December 31, 2021
Happy New Year! We closed 2021 on a strong note in equity markets, despite growing concerns about COVID resurgence, inflation, supply chain issues and the lack of available workers across the country. The S&P 500 advanced 11% in the fourth quarter to finish the year with a total return of +28.7%. The aggregate bond index slipped just -0.1% in the fourth quarter for a total 2021 return of -1.5%.
We shared the concerns noted above but decided to stay fully- to over-weighted in stocks for 2021 because bonds offered so little potential. This worked out well. There were several good quality companies with dividend yields higher than the U.S. Treasury 10-year bond rate, as you can see in the Strategas Research chart to the left. Where appropriate, we chose to employ some of those stocks in lieu of bonds to produce a higher rate of return for the overall portfolio, despite the fact most of these companies returned less than the S&P 500. This strategy succeeded in keeping our clients’ total returns higher.
Looking at the year ahead, we continue to see scarce value in bonds but also expect more volatility from stocks versus last year. Mid-term elections take place later this year. Historically, mid-term election years have sustained stock market pullbacks of -19% on average. They also tended to offer positive returns for the twelve months following the election, with the net result benefitting those who stayed invested. Such years are tough on the nerves, however.
The Federal Reserve will also be a focal point in 2022. Inflation data has worsened, and the Fed is now expected to increase rates at least three times over the course of this year. The fact that the rate increases are widely expected lessens the risk they will disrupt the stock market.
We also face a ‘fiscal cliff’ (sharp drop in government spending) in 2022. Outsized government expenditures to mitigate the economic impact of COVID have tapered off. On the positive side, state finances are strong and spending at that level could serve as a partial offset. A lot of companies and individuals pulled income forward into late 2021 to avoid potential 2022 tax increases, leading to a boon for state tax collections.
The Child Tax Credit that boosted family incomes has expired (although qualifying families can still claim some benefits on their 2021 tax return). High consumer spending will be supported by accumulated savings for the near term but that is not sustainable. Lower consumer spending may be a headline issue later this year.
We are accustomed to an exciting news cycle by now, and this year is likely to be no different. We are trimming some of our large equity positions but for the most part will stay the course in high-quality, diversified, market leading equities. Humility is valuable in any forecast, however. As Warren Buffett once said, “In the business world, the rearview mirror is always clearer than the windshield.” We will not hesitate to modify our strategy if the situation warrants it.