There were a record number of new issues in 2021, but only 22% of IPOs were profitable. Yet people still pour money into them. Investors hope to find the next Apple, Microsoft, or Tesla, but the odds are stacked against them. Especially since few investors can buy at the IPO price. They usually buy at the ‘opening’ price, which can be substantially higher. The disappointing 2021 numbers are not unique. IPOs have a history of underperforming. We stay away from IPOs for a number of reasons. The main one is that we don’t want to be buyers when insiders are selling.
Stocks have had a great run over the last three years with a compounded return of 90% for the S&P 500, or about 24% annually. Can stocks perform for a fourth year in a row? Wall Street is cautious about that which is unusual. Strategists normally forecast 10% price appreciation every year like clockwork but this year are only forecasting a 4.5% advance. Actually, a return of 5-10% is pretty rare. Most years produce very good or very bad returns, few in between. The S&P 500 rises two-thirds of the time with an average advance of 18%. Stocks decline one-third of the time with an average drop of 14%. We may be due for another correction, but market timing doesn’t work. It is best to stay the course. According to Peter Lynch, “The key to making money in stocks is not to get scared out of them.”
MARKET THEMES FOR 2022
Market returns, although unpredictable, usually boil down to a small handful of macroeconomic variables. It is important for investors to identify those factors and make decisions about how best to structure their portfolios. Here are five factors we think will drive 2022 equity returns:
– The economic boom continues (although with a pause coming in Q1). The economy is currently running hot (as evidenced by holiday sales up 8.5%), but Q1 estimates for GDP growth are plunging from 5% annualized to 2%. Why? Omicron is impacting our economy through flight cancellations, canceled sporting events and concerts, slower restaurant traffic, etc. It should be temporary, but time will tell. Expectations are for the economy to accelerate into spring and maintain above average growth for the remainder of 2022.
– Earnings are expected to rise 9.2% in 2022 on top of last year’s 45% gain (source: FactSet). Profit margins are at all-time highs. However, margins and profits are vulnerable to downside revisions due to slower economic growth in Q1, and a company’s inability to pass through price increases. Earnings are key for share price gains in 2022 because P/E multiple expansion is unlikely given current lofty levels.
– Inflation should cool this year. But when? From what level? Commodity price increases may pause, but what about food, gas, and wages, especially wages, which may be the key to the Fed sticking with their latest tapering plan announced December 15th? Persistent inflation may lead to higher interest rates sooner than expected, which could spook the markets.
– The recent revisions to the Fed’s plan to taper bond purchases and raise rates have been accepted by the market as evidenced by the strong December rally in share prices. Any disruptions (faster rate hikes) could provide an unwelcome surprise to investors and may cool the market.
– Covid remains a risk. Omicron may be a relatively mild variant, but it is still impacting our economy. When will Omicron subside? Are there more variants coming? Covid is a wildcard for 2022.
Of course there are some things that could go wrong for equities in 2022, but that is always the case. However, given all the uncertainty and rich valuations, we think the stock market will struggle to put up another year of big numbers unless earnings surprise to the upside. This will be an earnings driven market. Maybe Wall Street has it right.
Our equity focus is always large caps, but small/mid-caps could regain their momentum once we get through our Q1 GDP growth slowdown. We are adding smaller companies to portfolios as we still think the bull market is in the early/mid-cycle. We also like cyclical and value stocks as their valuations tend to be more reasonable. On the bond side, with interest rates likely to rise over the next few years, we are staying with our shorter-term maturity structure. And with spreads likely to widen between low quality (including junk) and high quality credits, we are staying with high quality.