If you were willing to look beyond the worrisome news, the stock market rewarded you in 2021. Forget COVID’s third wave (and the fourth). Don’t worry about inflation or the prospect of higher rates. For those that hung on to risky assets, the returns were there.
Global stocks returned a stellar 18.5% in 2021, making it the third year in a row of double-digit gains. The rise in inflation and anticipated rate hikes by the Fed weighed on bonds. The Bloomberg Aggregate bond index declined 1.5%, only the second down year since 2000.
It wasn’t all roses and sunshine in the stock market. Hysteria around “meme stocks,” SPACS, and cryptocurrency cooled towards the end of the year. What was once fun, exciting, and supposedly easy money for many new investors turned into steep losses. Despite the strong gains in the indexes, some of the most-speculative tech stocks declined on the year.
It was a strange year. Many of us learned to live with the virus. The vaccine rollout and advancements in COVID treatment gave many the confidence to return to some semblance of normal activity. Despite all this, there were more COVID-related deaths in 2021 than the year before.
After a decade of worries over the dangers of deflation, inflation had been all but removed from our collective vocabularies. But, juiced by low-interest rates and federal support, the economy ran hot and suddenly everyone was talking about inflation again. Saddled by supply-chain bottlenecks, the business sector couldn’t keep up with insatiable consumer demand. Gold, often thought of as an inflation hedge finished the year down 3.6% while consumer prices rose 6.8%. Perhaps, bitcoin, gaining 68% in the year, stole a bit of gold’s mojo.
A prodigious recovery in earnings drove the gains in the stock market. A simple way to break down the return on stocks is to separate the earnings (“the fundamentals”) from the price paid for those earnings. The price-to-earnings (P/E) ratio is a common measure of the latter. At the beginning of the year, the investors were willing to pay 30 times earnings for the blue-chip S&P 500 index – well above historical averages and implying optimistic expectations for earnings. Earnings exceeded those expectations, growing 65% over the year and outpacing gains in prices. The result is stock valuations ended the year lower (and stocks “cheaper”) than at the beginning.
This is unusual. Normally, valuations fall in conjunction with stock prices. But normal isn’t something we have been accustomed to in the last few years. You can interpret a lower P/E multiple as a good thing; investors are receiving more earnings for the price. But don’t read too much into this cheapening. Some of the premium that was priced into stocks was an expectation of a return to pre-pandemic levels in the economy and corporate profitability. Corporations met those expectations and then some. This may just be a return to “normal” levels of growth and profitability.
What It All Means
What should we expect in the year ahead? On one hand, bond yields have risen, and stock valuations have normalized, implying a better outlook for both stocks and bonds going forward. At the same time, stocks have posted three consecutive years of double-digit gains, an exceptional run by historical standards.
Anything can happen in a year’s time. That’s both meant to offer hope and offer a word of caution. When it comes to stock prices, the laws of gravity and statistical mean reversion don’t necessarily apply. After years of above-average gains, stocks don’t necessarily perform any better or worse than any other year.
Any number of curveballs could hit investor confidence this year. Upcoming mid-term elections will likely intensify tribal tendencies (how do you really feel about the economy?). Geopolitical risks are simmering as Russia eyes an invasion of Ukraine, and China continues to wrestle with an overbuilt real estate sector and a crackdown on tech companies. There is usually at least one 10% correction in stocks in every year. The frequency of those corrections has been less recently. Exactly what causes the correction will likely be something other than what’s listed above.
Greater volatility in stocks may cause indigestion, but it shouldn’t upset your financial plans. Stock investors should look beyond the near-term swings in prices and your risk should align with your goals.
Our reports to clients on another strong year of returns will be available electronically or mailed in the next few days. It is also a good time to review your goals and discuss any changes in your situation. We are available to schedule those conversations at your convenience.
We wish you and your family a happy, healthy, and prosperous new year.
Contact us at 865-584-1850 or info@proffittgoodson.com