As we embark on 2022 many market pundits are putting out their yearly predictions. We always find these more entertainment and theater rather than actual advice because the honest truth is, no one has any clue what the future holds and the market doesn't care about my opinion. Frankly there are always issues to worry about: Omicron shutdowns, new variant, supply chain glitches, labor shortage, school closures, higher inflation, rate increase cycle, Mid term elections, military conflict, etc. Our investment philosophy isn't predicated on predicting the future but rather reacting to current data. We use current and past data to help shape a thesis for potential outcomes in a scenario analysis manner. Then when events and conditions change we adjust our positioning and risk accordingly. The old adage sums it up perfectly, "the only constant in life is change".
With that said, to look out to next year we need to first assess what has actually taken place in real time. 2021 provided great returns across the asset class spectrum for everything except gold and treasuries. Jurrien Timmer from Fidelity sums this up in his table of investment returns.
Cathie Wood has taken a lot of heat this year as her Ark funds have under performed. But a simple ratio chart of the ARKK ETF to the SPY shows how dramatic the selling has been in high valuation growth names. ARKK peaked in February and has drastically under performed the S&P since then. Currently it is more than 50% of it's YTD high.
Most of the destruction in high beta growth can be attributed to the pivot from the Federal Reserve to speed up the tapering process to fight inflation they let get out of control. A tweet from Puru Saxena highlights how expensive stocks have lagged all year when plotted against the Fed's balance sheet.
This begs a bigger question. What is the impact from QE on the markets. Clearly quantitative easing has been a tailwind to the S&P. However, the reversal of QE (tapering) that reduces liquidity in the economy seems to be a headwind. The following two charts from William O'Neil touch on this.
On top of that the Fed's actions have historically triggered greater volatility.
The following two charts increase the likelihood for the potential for a more volatile environment next year. Low volatile years like 2021 are historically followed by more volatility.
The presidential cycle doesn't do any favors either. The first three quarters are weaker than normal heading into the mid term elections.
One of the biggest market concerns is the rate of inflation and the pace of interest rate hikes from the Fed. However, should we be scared of rate hikes? Bespoke has great data on this. What I found most interesting was, "as shown, the broad market tends to do poorly in the first three month of a tightening cycles over recent year, bu longer-term that's a buying opportunity as forward returns average 7.1% (86% positive) over the first six months follow a rate hike."
Ken Fisher validates this theory that the market shouldn't be spooked by rate hike cycles. Outside of the mid 70's stagflation, equity returns have been positive during rate hike cycles.
Some more data points in the bull case shows how strength begets strength. One of our favorites Ryan Detrick shows what happens after big up years in the S&P 500. The average return next year is 11.6%.
Another interesting stat lies in the fact that 2021 was a unique year. It was only the 5th time in history going back to the 1920's that the S&P finished up double digits three years in a row. We looked at what happened the 4th year after three straight double digit years. The returns surprised us.
| Year | Yearly Return |
| 1942 | 12.43% |
| 1943 | 19.45% |
| 1944 | 13.80% |
| 1945 | 30.72% |
| 1949 | 10.46% |
| 1950 | 21.56% |
| 1951 | 16.46% |
| 1952 | 11.78% |
| 1995 | 34.11% |
| 1996 | 20.26% |
| 1997 | 31.01% |
| 1998 | 26.67% |
| 2012 | 13.41% |
| 2013 | 29.60% |
| 2014 | 11.39% |
| 2015 | -0.73% |
| 2019 | 28.88% |
| 2020 | 16.26% |
| 2021 | 26.89% |
| 2022 | ? |
| Average 4th Yr Returns | 17.11% |
In conclusion, the data points to a mixed bag and has something for everyone. The bears can highlight tapering and volatility while the bulls can point to continued momentum. Our best guess is the first half will be more volatile than normal with multiple pullbacks. But as the supply chain gets worked out after Omicron dies down that should help inflation ease. Tapering should be done by the first quarter and we should have the first rate hike behind us sometime in the first half. That could set the stage for a second half rally as pent up demand comes on board and a strong finish once the Midterms are behind us. As I said in the beginning, the market doesn't care about my opinion. That is why we prefer to see how the tape reacts to new information and we'll adjust accordingly.
Happy New Year!
