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Hello to all and hope everyone enjoys the remainder of 2021. To begin, we want to keep this as short as possible so that everyone takes a moment to read it carefully. While we attempt to talk with everyone several times per year, sometimes it’s just easier to get some important points across in letter format. So please take just a moment to understand our thoughts on things as we move forward into 2022.
With that said, I think everyone believed putting 2020 in the rear-view mirror would be a way of making a fresh start post pandemic. Now I personally find myself thinking the same thoughts about 2021 as we head into 2022. While the Federal Reserve and the Federal Government blasted the economy with an atom bomb that proved to be a financial hero of sorts, it also appears to have created some short-term, and possibly longer-term, aftershocks that may or may not be felt for some years to come.
What do I mean? Honestly, I could write a book on this subject, so to keep it within the scope of this letter, I will make a few observations. First, it seems every asset class that exists - from housing, to stocks & bonds; from gold, to land; Bitcoin or ANY type of recreational item - is out of whack based on historical norms.
The stock market, measured by the Shiller PE (price to earnings) Ratio, as of the date of this letter, is just a few points away from its highest measured peak ever. That peak was 44.19 in December 1999; we are currently at 39.29. The mean is 16.90 (https://www.multpl.com/shiller-pe) meaning the stock market would have to drop nearly 60% just to hit it’s historical fair value. While valuation by itself is not a reason to buy or sell stocks, it gets our attention at these levels. In part, this dislocation has been created by historically-low interest rates and extreme monetary policy action.
Looking under the hood of the major indices, it appears once again 6-7 stocks make up most of the gains, and many stocks have fallen 10%-20% or more since February of 2021. This should be alarming if that handful of stocks break down. What would happen to the overall market? While stock valuations seem high, the momentum of the market has continued and until it stops, it’s anyone’s guess how high it will go. However, one would think some time within the next year, there should be a reversion to the mean. Since the pandemic lows in March 2020, the stock market has gone parabolic, and as such, it is unlikely to be able to continue on that trajectory. Something, at some point, must give and produce a reversion to the mean. Could the stock market go higher from here? Certainly! However, as we’ve experienced in the past 20 years, at some point, things get just too lopsided.
Looking at the chart of the SP 500, the rally is technically out of bounds. While we favor stocks for the long run, there could certainly be some turbulence in the next year or so, which continues to keep conservative investors cautious. If you have a long-term time horizon and are ok with market volatility, then over time, we would think history should continue to be on your side.
The questions will be surrounding the Federal Reserve, will they be able to raise interest rates in 2022? How will this affect investors’ willingness to pay up for stocks? What ripple effects will we see as a result?
What about bonds? This is generally the area of investment for more conservative investors. This, too, has been a challenge. For the most part, the bond market has experienced a negative return for 2021. Interest rates are at extreme low levels. Debt, too, is at an all-time high, the United States debt is over 29 trillion (https://www.usdebtclock.org/).
With interest rates so low, it’s difficult to generate a total return for investors. Many have thrown in the towel and scrambled to buy stocks. Generally, we see this as a capitulation of sorts that is often a sign of a top in stocks.
There are lots of questions going in to 2022. Will the pandemic turn into an endemic? While seasonality is generally favorable at year’s end, will volatility increase the first half of 2022 and bring valuations to a more reasonable level? That could prove to be a marker of sorts to get more involved in the stock market; however, with the Fed reducing its bond purchases and hinting to raise rates, inflation readings are the highest they’ve been since the late ‘70s & ‘80s, which is now triggering inflation. Asset prices have increased, commodity prices have soared and there have been supply chain issues due to the pandemic. Due mostly in part to technology advances, inflation has been at bay for the better part of 20 years. We’ve had spikes from time to time, but all in all, inflation has been subdued. In 2008, the price of a gallon of gas was about what it is today, 13 years later. Commodity prices have soared over the past year, albeit from low levels. The pandemic has created supply disruptions, yet when we get past the pandemic, these should level off and reduce inflation levels… hopefully.
Bottom line, there is a lot going on in the financial markets. There is no perfect asset class or product that can be an end-all solution. In my opinion, having a diversified portfolio over time is the tried-and-true method of investing.
It’s not all doom and gloom. Profits are robust and companies appear to be doing well in America. Like most of us, we want to be able to make money and don’t want to risk too much. Certainly, we are in challenging times that are difficult to navigate. Just buying the stock market and holding has proved well for several years, but at some point, looking away and holding your nose could prove detrimental. The stock market takes the stairs up and the elevator down during times of exuberance.
We urge you to fill out our risk profile if you haven’t already. We mention it often, either in conversation or through updates like this. Please visit www.GlobalWealthSolutionsLLC.com and click on the risk assessment quiz tab. It’s a five-minute exercise that helps us help you.