The financial markets are off to quite a tumultuous start so far in 2022; nonetheless, we hope this note finds you and your family living well.
We reserve our commentary on this particular section of our website for dramatic opportunities or market events, and this current market scenario now merits being addressed here.
As we put this note together, the S&P500 is down over 10% year-to-date and the Nasdaq is down over 14%. Prior to this correction, the last time the market dropped significantly was in March 2020 when the world was shutting down due to Covid-19. Prior to that market drop, we made a tactical risk reduction in the portfolios. You can revisit the logic here if you’re curious: Tactical Risk Reduction Amid Rising Conflicts
With this current market scenario, we have not made a substantial risk reduction and there are several reasons that we are choosing to remain invested.
2022 Earnings Expectations
Let’s start with a look towards earnings. The chart below shows the consensus estimates for the S&P500.
2021 Consensus Earnings – 205.981
2022 Consensus Estimate – 223.631
The market is expected to grow earnings by 17.65 points. This represents an increase of 8.57% over 2021 earnings.
Many investors see market movements to the downside and they begin to wonder – are we in a recession?
Well, a recession is typically defined by two consecutive quarters of negative GDP growth. In a recession, the economy is shrinking. In the US, the last quarter reported 6.7%2 GDP growth. The next GDP figures are reported at the end of January and the consensus expectation is for 5.5%2 growth. So, to answer the question – NO, the US is not in a recession.
Where Should We Invest?
There are three broad categories for investment assets – cash, bonds, and stocks.
Cash – We are avoiding parking assets here, particularly with the high inflation readings that have persisted over the last 12 months. The Consumer Price Index (CPI) rose 7% in 2021 – so while cash looks safe on the account statements, it actually lost 7% of its purchasing power. The Federal Reserve is taking action to combat inflation. Here is a link if you would like to hear more about this topic: Portfolio Commentary: The Taper
Bonds – Part of your allocation is comprised of bonds, and the weighting depends on how growth-oriented or conservative your portfolio is postured. Bond prices are inversely related with interest rates, so we have to be careful when we allocate in the middle of a rising-rate environment. If interest rates trend higher over the next 12 months, then this will be detrimental to bond prices.
Stocks—Stocks aren’t cheap by historical measures, but the earnings provided by stocks actually exceed the return that is available via bonds. We choose to tolerate the volatility that stock prices can deliver, but in exchange, we get an earnings yield that exceeds the return offered by bonds.
Where is the Relative Value?
Here’s a recap of the earnings yield based on current figures:
Earnings Yield on the S&P500 = 223.631 / 43251 = 5.17%
The yield on the 10-year Treasury Bond = 1.73%
Essentially, when we choose to own stocks in today’s environment, we are suggesting that the spread between 5.17% and 1.73% is wide enough to justify the risk.
Short Term Outlook
Take a look at the 2-year chart below. The recent pullback on the S&P500 has cracked through the red line, which is the 200-day moving average. This is a meaningful support level and it has our attention.
Now, consider the RSI indicator above it. A reading of 50 would be neutral, while a reading below 30 indicates that the market is oversold. Our current reading is below 24, so we could see the market finding a bottom around current levels and continuing forward from here. This type of chart-reading relies on tools that are similar to weather forecasting. The tools increase our probability of being correct, but data can change and our interpretation will adjust accordingly.
Earlier today, we adjusted all tactically-managed accounts so that the strongest year-to-date performers were trimmed and shifted to the parts of the portfolio that have seen the deepest declines.
A Wider Perspective
With the short-term commentary aside, notice the size of the pullback compared to the dramatic market move that we have seen over the last year. Even after this initial drop in 2022, our clients still have account balances that are higher than a year ago.
Volatile markets are part of investing, and this is why it is so important to pair solid portfolio management with customized financial planning.
Whether you are drawing income today or you have many years of growth ahead of you, we want to end by telling you that your portfolio is actively working to accomplish your objectives – even in this environment.
1: Yardeni Research
2: Bureau of Economic Analysis
Please add disclosure: The S&P 500 is an unmanaged index comprised of 500 widely-held securities considered to be representative of the stock market in general. You cannot directly invest in the S&P 500 index.
No investment strategy can guarantee a profit or protect against loss.