The S&P 500 posted a gain for the 7th quarter in a row during the three months ended December 31, 2021[i]. The index gained +10.65% for the quarter and +26.89% in 2021. Since the March 23, 2020, low, at the height of Covid-19 fears, the index closed the year up +113.02%.
Can the S&P 500 make it eight quarters in a row of gains?
Momentum is a powerful force in markets and the economy. One of the factors behind our portfolio design seeks to take advantage of the momentum. We have learned over the years that when the rate at which expected earnings are improving, stock prices typically rise and vice versa.
The improvement in expected earnings waned in the last six months of 2021 as increasing inflationary pressures and global supply chain disruptions had an adverse impact on corporate bottom lines. Given that the S&P 500 finished the year near all-time highs, it is our view that there is a reduced margin of safety for investing in stocks as we enter 2022. We highlight the weakening overall S&P 500 EPS expectations and rising stock prices with an “alligator jaw” opening in the chart below.
This divergence is what led us to rebalance in early October 2021 to take profits and slightly underweight equities. It is possible, and we are hopeful, that inflation and supply chain disruptions will abate, covid fears will subside and the Fed will keep monetary policy accommodative. If these scenarios play out as outlined, given the strong demand in our economy, we could see the earnings data improve and provide more strength to the markets. Given that the data isn’t providing these outcomes at this time, we do not want to rely on hope, hence our suggestion to capture gains and be somewhat cautious.
Ultimately, our view is that owning equities provides an advantage over the long run, and staying disciplined with your target asset allocation makes sense. While there may be reasons to be cautious in the near-term, no one knows what the future holds, and it does not mean that we believe investors should deviate sharply from this discipline.
As always, we look forward to our next conversation.