A Year in Review and Year Ahead
Updated: Jan 3, 2022
2021 was not as tumultuous as the previous year (2020), which was one the worst years ever as the COVID-19 pandemic led to an unprecedented global shutdown. 2021 was also far from calm, as new bad news confused and scared many throughout the year.
On the financial markets front and specifically in US large-cap indexes they were far more resilient. The S&P 500 Index, the Dow Jones Industrial Average, and the Nasdaq 100 Index traded at or near record highs just like the prior year.
New President/Mid-term Elections
The year began with great hope with a new President (Joe Biden). Upon taking office, Biden reiterated his campaign promise - America is Back. Nearly 11-months into his presidency, Joe Biden set a historic record, and not in a good way. The latest poll from Gallup shows President's approval rating plummeting to the lowest level since his inauguration. His approval is among the lowest of any US President in the past five decades. Despite the poor showing, this is the first year of the US presidential election year cycle, and true to form, it was another stellar year for stocks.
Based on the presidential election cycle study, the second year of the presidential election year cycle, coinciding with mid-term elections, tends to be highly volatile, leading to the potential for stock market cycle lows. Into late-summer to early-fall, voters and investors begin to focus on politics and the control of Congress. Markets do not like uncertainties, political and otherwise. The concerns surrounding the election results and future policies translate to elevated market volatility weeks and months before the mid-term elections. The silver lining for investors is that after suffering a bout of high volatility and potentially another 4-year stock market cycle low, the stock market tends to bounce back strongly soon after the mid-term elections. Stocks tend to perform well into the second half of the 4-year presidential term, namely years 3 and 4. For instance, since 1950, the average 1-year return (15%) from the mid-term election is approximately double that of all other years (7%).
Delta Variant/Omicron Variant
The year started with guarded optimism that the worst pandemics in the past 100 years would subside with the new vaccines. The speed of the development of Covid-19 vaccines was astounding. Vaccines historically take around ten to fifteen years to develop. The Mumps vaccine took over four years before it was released. Pfizer and Moderna vaccines were created, tested, and approved in less than a year. Unfortunately, many people who were eligible to be vaccinated chose not to. Many more who wanted to get vaccinated could not.
The Covid-19 virus has been incredibly adaptive and resilient. The original coronavirus quickly mutated into the deadly Delta variant earlier at the beginning of the year. Toward the end of the year, it has been replaced by the highly contagious Omicron variant as the dominant virus worldwide. It is clear is the pandemic remains a global health threat. Today, there are 285 million Covid-19 worldwide cases, 5.4 million global deaths, and 823,000 Americans died from COVID-19.
Unless you are a virologist, it is difficult to know if Omicron will become as severe as the Delta variant. It is even more challenging to determine if a new lethal variant will overtake Omicron next year. Despite the rising fears the Delta variant will lead to restrictions and slower global economic growth, it has proven the naysayers wrong once again as stocks have held up relatively well. Looking at the SPX charts, investors expect the Omicron variant will be successfully managed, as the global economy grows, albeit at a slower pace.
Over the past year, SPX has consolidated seven (7) times. Each of the pullbacks was 3.5-6%. The consolidations may have alleviated the overbought conditions allowing investors to buy the dips. Healthcare experts suspect US Omicron cases may begin to peak by late-January 2022. Stocks and bonds seem to agree with this call. Will stocks stage a strong first-half rally and fade into the second half of the year as uncertainties surrounding the Omicron spread reemerge? What will happen if a new variant emerges?
With one day left before the end of the year, the SPX chart hints that the worst may be behind us, at least over the near term. SPX index has rallied 27.14% on a year-to-date basis, the Dow Jones Industrial Average has gained 18.92%, and Nasdaq Composite Index has appreciated 22.14%. It may be challenging for SPX to repeat the stellar 2021 returns. However, if the Omicron variant is not severe, and no new variant emerges, SPX can return the 7-8% historical returns ex-dividends next year.
Supply Chains Bottlenecks/Inflation
Supply chains became a household word during 2021. For many years companies have outsourced production overseas. The strategy worked flawlessly. Companies reduced their cost, were more productive, and expanded their distribution channel, resulting in higher profits and revenues. The onset of the COVID-19 pandemic created a headache for everyone. It exposed the downside of the supply chains. At the heart of the pandemic, many factories closed. Companies let inventories fall too low to avoid holding onto unsold merchandise. When the global reopened, the sudden surge in consumer demands left many companies holding on to too few parts and supplies. The limited number of shipping containers and too few truck drivers led to the bottlenecks at ports, further exacerbating the existing supply chains problems. Many blame the supply chain disruptions caused by the COVID-19 lockdowns contributed to the sharp rise in the inflation rate. The question is whether the supply chain bottlenecks can abate and if other underlying problems may be causing higher inflation to persist.
The two financial markets most sensitive to inflation are interest rates and commodities. The 10-year US Treasury yield (TNX) and CRB Index (CRB) can help gauge whether inflation is sustainable or longer-lasting. TNX started the year at 0.917% and spent the bulk of the year confined to a trading range between 1.128-1.129% (Jul/Aug 2021 lows) and 1.69-1.765% (Mar, May, Oct, and Nov 2021 highs). Applying a linear regression study to TNX over the past year points to 1.17-1.25% as a pivotal level. TNX convincingly violates 1.13-1.17%, this hints that the supply chains bottlenecks and inflation may be subsiding. A breakout above 1.69-1.765% warns of further supply chains problems and higher inflation?
Fed Monetary Policy – Tapering, Hikes, Soft or Hard Landing
The loose monetary stance by the FED and the government's massive economic stimulus packages in recent years have led to an increase in liquidity. It may have prevented a more severe financial crisis but may have also created another challenge – rising inflation. Fed's recent announcement of the acceleration of the tapering program and rate hikes can lead to a soft or hard landing.
From a technical perspective, look for a market response as the ultimate confirmation of the successful implementations of monetary and fiscal policies. The stock market (SPX) remains a leading economic indicator and is forward-looking. The yield curve spreads, and the shape of the yield curve can also be dependable in predicting changes in the economy (i.e., inflation, recession, stagflation, etc.). The spread between the 10-year yields minus the 3-month yields and the shape of the yield curve remains bullish, as evidenced by the continuation of the large cup and handle breakout. Above 1.62-1.73 confirms another breakout and signals the resumption of the steepening trend, suggesting an expanding economy and possibly higher inflation. Below 1.14-1.16 warns of a breakdown and the start of a deeper contraction in spreads, implying lower inflation.
Whether a soft or hard landing will prevail will depend heavily on the bond market reactions. Also, specific stocks/sectors (cyclical versus defensive) can alert to the changing economic trends. A recent study of the sum of the parts analysis suggests the biggest driver of stock market returns for 2021 came from growth in corporate profits. In prior years, stock market returns came from price-earnings expansions as investors were willing to pay more for each dollar of earnings, resulting in price-earnings multiples rising. When the growth in corporate profits declines, as some market pundits are alluding, the stock market can end up with a two-tiered market environment. A balanced equity portfolio may help weather the uncertainties. Cyclical, value and reopening stocks may perform well during the early parts of 202. Secular growth areas such as Technology, Communication Services, Healthcare, and dividend growth may perform better into the second half of the year as the economy transitions toward a steadier but slower economic growth trend.
Stock Market 2021: Bull with a few Consolidations and 2022: Melt-up Phase
Since the Mar 2009 SPX market bottom (666.79), the dominant and prevailing structural trend remains intact via the 12-year uptrend channel between 3,292-3,465 and 4,748. The ability of SPX to convincingly clear above the top of the 12-year uptrend channel at 4,748 confirms an accelerated channel breakout and suggests +1,456 points or an SPX target at 6,204, longer-term. The 10-month ma (4,383) and the October/December 2021 intra-month lows associated with the positive outside months at 4,279 and 4,495 offer crucial initial supports. The 30-month ma at 3,608.5 and the bottom of the channel at 3,292-3,465 provide longer-term support.
On another bullish note, it appears another positive outside month pattern has developed in SPX during Dec 2021. Three positive outside months (Mar 2021, Oct 2021, and Dec 2021) hint at buying pressure and bullish sentiments. A strong rally heading into year-end can carry over into the New Year (2022), resulting in new all-time highs. Will this lead to the start of the melt-up phase to the 8-year plus structural bull rally? Watch the spread between the 10-mo ma (4,383) and 30-mo ma (3,608.5) for signs that the stock market is trading at extreme levels.
We wish you and your family a Happy, Healthy, and Safe New Year.