by Justin Long, on Dec 03, 2021
Volatility returned in a big way over the last few trading sessions, with this being the case I wanted to get the thoughts of where things are and what things are having an impact of how we are managing our portfolios to all of our clients, please see the below notes from our Portfolio team. After digesting these thoughts please feel to use this link to book a call so we can discuss your specific portfolio -
Where We Were
2020 was an extraordinary period for almost all risk assets, with all of the primary benchmark indexes rallying significantly off March lows. The All‐Country World Index (ACWI) printed a total return (price appreciation plus dividends) of 16%. Foreign developed markets (EAFE) returned 8%. Emerging markets (EM) 17%. The S&P 500 large cap index 18%. Mid cap 14%. Small cap 20%. Large cap growth 33%. Large cap value 1%. The U.S. Aggregate Bond index (AGG) rose 8%. Treasuries 7%. Agencies 4%. Corporates 11%. High yield (junk) bonds were up 5%. TIPS 11%.
Where We Are
We’re in another 4‐5% pullback following recent new highs. YTD, the S&P 500 is up 23%, compared to 7% for developed foreign markets and ‐5% for emerging. Large cap leads again up 23%, with midcap +18% and small cap up 12%. Growth leads again, up 29% vs. 17% for Value. Sector leaders are Energy +49%, Real Estate +33%, Financials +30%, Technology +30%, and Consumer Discretionary +28%. Laggards include Consumer Staples +6% and Utilities +7%. The top performing sector QTD is Consumer Discretionary, up 14%; the worst is Communication Services, down ‐6%.
Within fixed income, intermediate and long bond indexes remain under slight pressure from inflation but have rallied on equity declines, with 1‐3yr Treasuries off ‐1% and 20+yr Treasuries off ‐3% (+3% in the past month). Core intermediate bond sectors all still off less than ‐2% YTD. Intermediate (7‐10yr) benchmark Treasuries, Agencies and Corporates are down ‐2%, ‐1% and ‐2%, leaving the US and International Aggregate indexes down by ‐1.4% and ‐1.3% YTD. High yield is up 1%. TIPS 5%. Munis 1%. Gold ‐7%. On the short side (6 month duration), Treasuries yield 10bp, Agencies 10bp and Corporates 50bp. Pre‐COVID, these yields were 160bp, 160bp and 200bp (when Fed Funds was 250bp). These yields help explain why cash management/short duration strategies are foundering, and will likely continue so until short rates rise.
Q3 Earnings Review:
For Q3 2021, with 95% of S&P 500 companies reporting, 82% have exceeded EPS estimates and 75% have beat revenue targets. YoY, Q3 earnings growth for the S&P 500 is 40%, following a 92% increase in Q2. The consensus estimate at the end of the quarter called for a 27% increase. So far, Q3’s results are the third highest year‐over‐year earnings growth rate since Q2 2010. All 11 sectors exceeded expectations for revenue and earnings. S&P 500 earnings estimates continue to rise. According to FactSet, the forward 12‐month estimate for the SPX is $219, up from $216 last month, $200 at the end of Q2, $181 at the end of Q1, and $165 on January 1. The COVID cycle low was $143 in July 2020. For calendar years 2021 and 2022, current estimates are $203 and $222, up +46% and +10% ‐ and both revised upward since the end of the quarter. Calendar 2021 and 2022 P/E ratios are 22x and 20x, for PEG ratios of 0.5x and 2.0x. Over the past 20 years, the average S&P 500 earnings growth rate was 8%, with a P/E of 18x, and a PEG ratio of 2.3x. The consensus target price for the S&P 500 is 5050, or +12% from today’s close.
Where We’re Headed
The Tapering Fed. “Don’t fight the Fed” remains true, though some folks are getting skittish about the extent and timing of policy and open market changes. Following last month’s meeting the Fed is “only” purchasing securities worth $105 billion
per month, down from $120 billion. Over a year, that equates to $1.26 trillion. However, we likely won’t see a year’s worth of purchases given the Fed’s revised tone on inflation risks etc., but an average of half the current amount of asset purchases over the next year would total $630 billion in additional liquidity injected into the financial system. The other component, the Fed Funds policy rate, is expected to rise perhaps earlier in 2022, though again off a 0%‐0.25% base. It is safe to say the Fed has been slow to change its tone compared to market changes. Though frustrating, a lagging Fed ‐ whether hawkish or dovish ‐ is not uncharacteristic since at least the time of Greenspan. “Too low for too long” could be the Fed’s new catchphrase. However, for our purposes excess liquidity is normally a tailwind for equity prices, which usually more than offsets weakness in bond total returns. Wouldn’t we much rather see equities up 20% with bonds ‐2% than equities up 10% with bonds up 4%? Most individual clients are neither 100% fixed income, nor 100% equity, and a better equity market equates to higher returns after inflation, more than compensating for per unit inflation. New COVID strains vs. mortality. We aren’t no experts in virology, but from what we’re gathered from credible sources, viral mutations tend to be MORE infectious, but LESS deadly. Mutations are also very common and very expected, whether in the arena of bacteria or viruses. Remember as we get bombarded with another cycle of negative news on Omicron or whatever strain is up next, the most at‐risk age group in the U.S. (65+) is at 98% for at least one dose of a COVID therapeutic. Add to overall vaccination rates the elephant in the room: natural immunity from successful, nonpharmaceutical‐based antibody production in the human body. By now, 2 years in, billions of people worldwide have been exposed to COVID and not been hospitalized nor died. Again, according to the Mayo Clinic website, despite new strains like Delta with high infection rates, THE MORTALITY RATE HAS NOT INCREASED. IT REMAINS JUST 1.6%, DESPITE NEW INFECTIONS FROM VARIOUS STRAINS. (https://www.mayoclinic.org/coronavirus‐covid‐19/map).