Commentary on the Market: Fourth Quarter 2021 and Navigating First Quarter of 2022
Ruben’s Commentary on the Market
2021 FINANCIAL YEAR END SUMMARY
2021, much like 2020, continued to provide new highs in the stock market, despite the countless challenges that kept investors, businesses and the world dealing with an evolving landscape. Despite the global spread of COVID variants, supply chain issues, inflation exceeding expectations and a shortage of a sufficient workforce, the major stock indexes scored big. Both the S&P 500 and NASDAQ were up well over 20% and the DJIA was up over 18%. Many ask how this can continue with all the negativity that we are dealing with. The simple answer is that if both individuals and corporate consumers have cash to spend on goods and services, companies will continue to generate strong earnings. After all, positive earnings are what make stock values go up. Earnings rule the value of stock. Good earnings will drive the value of a stock up and poor earnings drag a stock value down.
The markets have been volatile since the end of November with distractions such as spikes in COVID cases, supply chain issues and of course the acceleration of inflation that has even surprised the Federal Reserve Bank. These events have caused nervousness with investors. 2021 did end up strongly, despite being up and down through the month of December as the financial media jumped into high gear reporting on the pitfalls that the markets were facing. The media prospers on ratings.
January took the lead from a rocky December and has tested the markets further. Tech companies have taken the heaviest hit over the past several weeks with the NASDAQ officially going into correction territory, having fallen over 10% from its highs. Market corrections, which are defined as a particular index falling over 10% from its previous high, are not a new phenomenon. In fact, even in calmer environments, two to three correctionsof10%ormoreinanyoneyeararenotoutoftheordinary. Wall Street likes to shake up the markets from time to time. This correction has occurred over the first three weeks of 2022, driven by the repetitive news of COVID, the Fed’s dealing with inflation, supply chain blockages, and the fear stoked by the financial media. Since 1971 the markets have experienced 31 significant corrections, only to come back when dust settles. We haven’t had a pullback of this nature since March of 2020.
There are at a minimum two solid reasons that the markets are likely to head back into positive territory. One is historic statistical data and the second is expected positive earnings reports. First, Truist Advisory Services, a nationally recognized firm, recently presented market data from 1950 through 2021. In that period, when the S&P 500 had a total return of at least 25% in a year (27% in 2021,) stocks rose the following year. This has been true 82% of the time over the 71 year period or 14 out of 17 times. Secondly, we have entered the fourth quarter earnings season with positive expectations. Consensus estimates are projected to show 22% growth in S&P 500 companies. Yes, earnings should continue to drive the markets upward.
How can earnings continue to grow when there are so many obstacles facing investors? There is still a lot of money on the sidelines. Corporations have stockpiled cash from past and current earnings. From the consumer standpoint there are fewer people working, but they are being paid more to stay on the job. Goldman Sachs recently raised compensation by as much as 30% to some employees in order to keep them from being recruited away. Despite prices on goods going up, the additional pay is making it more comfortable for many consumers to continue spending. Our economy is a consumer driven economy, with the individual consumer accounting for 40% of GDP. When you further add in corporate spending the earnings will continue to grow.
Prices are still rising. Gas at the pump continues to go up, we are paying more at the grocery store, and housing prices are projected to rise another 10% this year. We still have another two million jobs to fill to get back to pre-COVID employment levels. When those jobs are filled there will be more money chasing product. Despite the average consumer spending more, being paid more additionally allows for increased savings. Spending will temper but will remain steady and interest rates will slowly begin to drop as the Fed takes action to slow inflation. However, prices will most likely remain higher and not return to previous levels. The consumer will get used to paying those prices and corporate earnings should continue to grow with increased profit margins.
The story is clear. Yes, we are dealing with much drama aided by the media. COVID doesn’t want to go away anytime soon. We may well end up dealing with COVID and its various evolving forms going forward, much like we do with the flu. Many of us take a flu vaccine annually and it has become part of our health protocol. There are several companies now that are studying possible influenza/COVID combinations. Additionally, supply chain issues and getting product from boat to store or factory has created many problems. Demand has not weakened. The solution is expanding the supply chain workforce. Household spending increased 5.1% in 2021, a Fed survey showed. Part of the increase in prices comes from inflation spurred on by supply shortages. Consumer prices jumped 7% in 2021. However, change will happen when the consumer begins to back away from aggressive spending, slowing excessive demand. Slowing demand should have an impact on slowing inflation and allow prices to eventually balance out. Retail sales slowed in December by 1.8%. The Federal Reserve Bank governors meet this week and will begin sorting out a direction to take in dealing with inflation. The Fed will act to slow inflation and in all probability will begin to raise interest rates sooner than later. That is expected and should take one unknown out of the picture.
Should we be concerned about the volatility we are experiencing in the markets. We should be concerned, but not panicked about the news of volatility, inflation and the Fed tightening. The Fed is going to be raising rates. This is not bad. The current Fed funds (interest rates) are currently at “0%” and the Fed has pushed rates down in order to lift the economy from previous recessions making money less expensive to borrow. The Fed has succeeded. Our economy is growing and in a recovery. I recently heard analogy of a what we are experiencing. The “0%” interest rate scenario is like supporting a newborn to the point of walking on their own. Afterwards the parent pulls away and allows the young child to take steps on their own. This is where our economy currently stands. Our economy is in a recovery and it is expected that the Fed will get rates back up to normal levels. As this happens, inflation will moderate based on normal checks and balances of a healthy economy. This is good.
Please feel free to reach out to me with any questions that you may have.
Best regards, Ruben E. Guerra