Shannon Jones, CFA, CFP®
Senior Portfolio Manager
January 3, 2022
As we enter 2022, we are nearing the two-year mark of the COVID-19 pandemic that shook global economies and markets; and as new strains of varying concern continue to emerge, some are wondering if this will transition from being a pandemic to an endemic. Only time will tell, but for now, we know the official “return to office” remains elusive, supply chains remain constrained, demand remains exceptionally strong, and global central banks are starting to rein in their ultra-accommodative monetary policies.
So, what does all this mean for our JGP portfolios and where are we positioning ourselves in 2022?
Let’s start with valuations. S&P 500 equity valuations remained above historical averages throughout 2021, driven by strong earnings and revenue growth. In fact, margins for U.S. corporations hit an all-time high in the second quarter of 2021. With a large portion of the U.S. economic recovery already complete, a strong rebound in corporate revenues has already been realized. While we have confidence domestic companies will continue to see strong demand and growing revenues in 2022, we believe the numbers will return to a more normalized value, as the double-digit growth rates seen in 2021 are not sustainable.
Valuations seem more reasonable in developed international and emerging markets, where countries experienced rolling lockdowns throughout 2021 and economic recoveries trail that of the U.S. In 2022, through a combination of naturally acquired immunity, the potential introduction of an oral antiviral pill, and the abandonment of countrywide lockdowns, we expect overseas economies to be able to overcome the pandemic. This should lead to more coordinated global growth and, more importantly, above-trend growth for international economies.
Given these considerations, we feel it will be beneficial to increase our satellite strategy exposures within our overall equity class exposure. This will give us increased exposure to U.S. mid- and small-cap companies, developed international, and emerging markets.
Next, we look at sentiment. Despite strong returns in equity markets, 2021 was a difficult year to trade as market breadth narrowed. Market breadth measures the number of stocks moving in the same direction, whether positive or negative. When market breadth is high, more stocks are moving in tandem and when it’s low, a smaller portion of stocks are moving together. According to Goldman Sachs estimates, from April 2021 through mid-December 2021, more than half the return of the S&P 500 could be attributed to only five stocks: AAPL, MSFT, NVDA, TSLA, and GOOG.
Economic uncertainty and retail traders piling into markets also made 2021 a difficult trading year. New variants of COVID-19 and unknown government responses, rapidly rising inflation and increased expectations of Fed action, and an on-again/off-again return to normalcy all led to frequent rotations between investment styles, sectors, and factors. Additional anomalies driven by retail investors, such as the meme-stock frenzy and a surge in options trading, contributed to significant non-fundamental stock trading for the year.
In this environment, proper investment management and stock selection are imperative. We remain committed to our philosophy of owning well-run companies with strong cash flows and sound balance sheets, as these companies should weather short-term market abnormalities and be expected to perform well over the long term.
Last, but certainly not least, we consider the Federal Reserve and monetary policy. Throughout 2021, Fed Chairman Powell was unwavering in his commitment to keeping monetary policy ultra-accommodative. Initially, the FOMC was concerned with getting the economy back to full employment. But as the year progressed, inflation rapidly increased to a 30-year high, and it became apparent not all eligible participants would return to the workforce. In November, the announcement was made that the Fed would begin tapering its bond purchases at $15B/month, followed only one month later with the announcement that the pace of tapering would increase to $30B/month. Ending asset purchases sooner provides the Fed more leeway in their timing of increasing interest rates.
Currently, asset purchases are on pace to conclude in March 2022 and the Fed expects three interest rate increases thereafter, as long as economic conditions maintain their current trajectory. While the Fed appears to be easing off the gas pedal of ultra-accommodative monetary policy, they are by no means tightening policy. Even if we do see all three rate increases this year and another three increases in 2023, the Fed Funds Rate would still be below the rate of inflation, thus rendering policy accommodative.
Inflation is one of the main reasons for the change of tone from Federal Reserve members. While rate increases should begin to rein in inflation, it will not disappear overnight. Historically, one of the best ways to fight longer-term inflation is exposure to equity markets. For this purpose, we will be slightly increasing our equity exposure across portfolios. We will also look to increase exposure to sectors that are poised to benefit from a rising rate environment accompanied by economic growth, such as financials and technology.
Overall, for 2022 we expect a more synchronized global growth picture, which should lead to strong economic and earnings growth. While inflation seems to be top of mind for investors, our core investment philosophy has led to the creation of portfolios that are historically less sensitive to inflation than the general stock market. We believe this fundamental component, along with the tactical changes being implemented, should well-position our portfolios to take advantage of continued economic growth and rising interest rates.
Lastly, all of us at JGP would like to thank you for your ongoing support of our firm. 2021 was a record year for new referrals to the firm, which surpassed the previous record set in 2020. We continue to add incredibly talented team members to JGP to accommodate our growth. In an industry with no guarantees, we offer two: to always put your interests ahead of all others and to passionately show up every day, to do our best, to help you live the life you want.
This commentary in this email reflects the personal opinions, viewpoints and analyses of the JGP Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by JGP Wealth Management, LLC or performance returns of any JGP Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. JGP Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. No advice may be rendered by JGP Wealth Management, LLC unless a client service agreement is in place. Please contact us at your earliest convenience with any questions regarding the content of this presentation and how it may be the right strategy for you. For actual results that are compared to an index, all material facts relevant to the comparison are disclosed herein and reflect the deduction of advisory fees, brokerage, and other commissions, and any other expenses paid by JGP Wealth Management, LLC's clients. An index is a hypothetical portfolio of securities representing a particular market or a segment of it used as an indicator of the change in the securities market. Indexes are unmanaged, do not incur fees and expenses, and cannot be invested in directly.