Rewind, with me, two years to January 2020. The stock market was coming off a great year (up almost 30% in 2019) and the economy was humming with employment at its highest level in over 60 years—yet people were nervous. “This market has got to crash. It can’t keep going like this,” was a familiar refrain in early ’20 client reviews. We comforted with cheery counsel that, aside from something weird happening, we felt like the current bull market still had room to run. Then, in March ’20, the weirdest thing ever happened, and the market nosedived like never before.
The world elected to respond to the onset of the pandemic essentially by shutting down the global economy—placing it, if you will, in a kind of medically induced coma. In this country, we experienced the fastest economic recession ever, and a one-third decline in the S&P 500 in just over one month. Congress and the Federal Reserve responded all but immediately with a wave of fiscal and monetary stimulus which was and remains without historical precedent.
To those who lamented it would take years to recover the losses sustained in those 33 days, we offered optimism, even in those darkest hours, that the market would recover and likely finish the year higher than it started. We predicted and later witnessed the market execute an almost symmetrical V-shaped recovery in the month following the March 23rd market bottom and then continue climbing to a new all-time high on August 18th, 2020. The full roundtrip (peak-to-trough-to-peak) took one day shy of six months—despite the absence of a vaccine and the lingering effects of the economic lockdown. We warned that election-year stock markets tend to be choppy leading up to election day, and while it’s fairly typical to see a strong finish once the political uncertainty has passed, no one would’ve predicted that 2020 would end with such a flourish. Despite the pandemic-induced bear market, the S&P 500 (index of 500 of the largest U.S. companies) rallied to end 2020 just over 16% higher than it started and up over 18% including dividends!
2021 began full of hope and apprehension. We were assured that a vaccine rollout was imminent but cautioned regarding its long-term efficacy. We were presented with new leadership, but it seemed political division and discord were still in charge.We were given a hint that life was finally returning to normal, then Delta cast its long shadow over the globe.
Early ’21 indeed saw the rollout of a trio of COVID vaccines, and by spring, despite lingering fears, Americans began to venture out. Restaurant reservations marched upward toward pre-pandemic levels, and airlines, for the first time in over a year, suddenly faced the challenge of finding personnel, not passengers. Finding personnel seemed to be a common theme as businesses, in an effort to attract workers, offered higher wages and signing bonuses.
Oddly, aforementioned headwinds aside, 2021 was a banner year for investors with the broad-based S&P 500 Index finishing the year up 26.9%-- 28.7% including dividends, according to S&P Dow Jones Indices.
Corporate profits are a key driver of stock prices, and much better-than-expected corporate profits, powered by an expanding economy and super easy monetary policy compliments of the Federal Reserve, deserve much of the credit for the 2021 market expansion. Low interest rates, low bond yields, and rising profits easily offset worries about the lingering pandemic and much higher-than-expected inflation.
As we look ahead at 2022, we naturally wonder the new year might bring. After 2021’s strong advance, can the market maintain this breakneck pace? What dictates the market’s trajectory will likely be the economic fundamentals and factors that impact those fundamentals.
For example, what will the Federal Reserve do with interest rates? At the beginning of 2021, the Fed expected no rate hikes in 2022; however, it failed to anticipate last year’s surge in inflation. As the year ended, the Fed’s new projections, which it released after its December meeting, reflected a forecast of three quarter-percentage-point rate hikes this year. Is January’s stock market stumble investors’ attempt to ‘price-in’ these projected rate hikes? If inflation fails to ease--or worse, accelerates--could the Fed take a more aggressive posture?
How will the pandemic play out? First there was Delta, and most recently we’ve seen a surge in cases tied to Omicron. The economic impact of Delta was limited. Recent shakiness in the market will no doubt be attributed to economic worries about Omicron, but is it, and what does it tell us, if anything, about what 2022 holds? If 2020 was the year of the virus, 2021 was the year of the vaccines. Vaccination as well as acquired natural immunity are in the ascendancy, regardless of how many more Greek-letter variants are discovered and trumpeted to the skies as the new apocalypse. This fact, it seems to me, is the key to a coherent view of 2022.
In general, it’s most likely that in the coming year (a) the lethality of the virus continues to wane, (b) the world economy continues to reopen, (c) corporate earnings continue to advance, (d) the Federal Reserve begins draining excess liquidity from the banking system, with some resultant increase in interest rates, (e) inflation subsides somewhat, and (f) barring some other exogenous variable—which we can never really do—equity values continue to advance, though at something less (and probably a lot less) than the blazing pace at which they've been soaring since the market trough of March 2020.
Please don't mistake this for a forecast. All we are saying is that these outcomes seem more likely than not. We’re fully prepared to be wrong on any or all of the above points; and if/when we are, our recommendations to you will be unaffected, since our investment policy is driven entirely by the plan we've made, and not at all by current events. Downturns are a normal, healthy part of the stock market cycle and investing in general. We readily recognize the challenge in predicting the future, but more importantly, its irrelevance. As you’ve no doubt heard us say countless times: Successful investors act continuously on a plan while failed investors react continually to current events.
Imagine you had a crystal ball, and in March of 2020 you looked into the future and saw that almost two years later we’d still be dealing with a worldwide pandemic, that the global economy had yet to regain its footing, that there would be labor shortages and supply chain disruptions causing spiking inflation and rising interest rates, and that government gridlock was alive and well.Presented with this reality, most rational people would say, “I’m getting out of the stock market until things settle down and the future looks brighter.”Anyone who followed what seemed like the prudent path and got out in early/mid 2020 would have missed what may be the best 18 months in our investing lifetime.
There are two lessons to be derived from these last 18+ months:
Lesson 1: No one can consistently predict the future—even when it seems obvious. Very few (us included) could have imagined the far-reaching and long-lasting impact of this virus, but even more important is Lesson 2.
Lesson 2: Apparently, even if we could predict the future, it wouldn’t provide meaningful insight or instruction as to how to invest our lifetime and/or multigenerational wealth.
So, what is the takeaway from these very clear messages? Attempting to predict the future as a guide to investment policy is an utter waste of time and emotional energy.
To those who cry in fear, ‘I think the market is too high. I feel like it’s going to crash. My gut is telling me to get out until everything settles down,’ we continue to comfort and counsel that all-important financial decisions should be based on facts and data, not feelings and hunches. Make no mistake, we are in the midst of a fiscal and particularly a monetary experiment which has no direct antecedents. This renders all economic forecasting—and all investment policy based on such forecasts—hugely speculative. I infer from this that if there were ever a time to just put our heads down and work our investment and financial plan—ignoring the noise—this is surely it.
And, while we can’t control near-term market volatility, there are aspects of our financial lives over which we have complete control and from which we can draw strength and confidence. Aspects over which we have control include mapping out a plan to provide a predictable, sustainable, and growing income stream through retirement. We can control our allocation to ensure we are adequately prepared to ride-out inevitable downturns in the market or economy while ‘keeping our sails up’ to take advantage of growth opportunities when the wind is at our back. By understanding the tax code, we can make smart moves to minimize taxes throughout not only our lifetimes, but those of our kids and grandkids, as well. Because we can’t always see what’s coming, we make sure adequate insurance is in place to protect our family if/when they need it most. And, finally, if we do everything right, we can take steps so that our financial legacy passes efficiently to the people and organizations we care about most.
With that out of the way, allow us to offer a more personal observation. These have undoubtedly been the two most shocking and terrifying years for investors since the Global Financial Crisis of 2008-09—first the outbreak of the pandemic, next the bitterly partisan election, the pandemic's second wave followed by a 40-year inflation spike, and, most recently, the Omicron third wave. You might not be human if you haven't experienced serious volatility fatigue at some point. I think we all have.
But like all similar episodes throughout history, what came to matter most was not what the economy or the markets did, but what the investor himself/herself did. If the investor fled the equity market during any of our recent crises, his/her investment results seem unlikely ever to fully recover. If on the other hand he/she kept acting on a long-term plan rather than reacting to current events, positive outcomes followed. It was ever thus and expect it always will be.
“If you change your investment policy, you’re probably wrong, and if you change it urgently—in response to current events—you’re guaranteed to be wrong.”
-- Charlie Ellis, American Investment Consultant
Based on your goals, circumstances, and risk tolerance, we craft portfolios that help manage risk, but we can’t eliminate volatility. Adherence to one’s financial plan and a long-term focus have historically been the straightest path to reaching one’s financial goals. We may see volatility this year, but predictions are simply educated guesses. As we’ve seen in the past, sell-offs, when they occur, are followed by rebounds. Keep this in mind as we navigate the New Year together. [Fun fact: Historically, the 2nd year after a selloff (ie: 2022), the market is up 100% of the time, but with a 10% average pullback at some point during the year.]
As I write, at just over 4,430 on the S&P 500, the broad equity market is up 98% from its pandemic low on March 23, 2020. While this is certainly gratifying, it doesn’t proceed from our having been “right about the market,” other than in the largest, longest-term sense. Our/your positions in the equity market are a pure function of their being historically best suited to your lifetime financial (and especially retirement) planning. They are never based on a view of the economy and the markets, which we continue to believe can neither be forecast nor timed.
Stated another way, we aren’t “right” because the market was up 26% last year, any more than we’d be “wrong” if it were down 25%. Our investment policy is the same as it’s always been—even (and especially) when the market declined 34% in five weeks in February/March of 2020. Simply stated, that policy is based on two enduring beliefs: (1) That the historical long-term premium return of equities over bonds is necessary to the achievement of your most important long-term financial goals. (2) That the only way to be reasonably sure of capturing the premium return of equities is to ride out their frequent, but historically temporary, price declines.