Year End Market Commentary

Well, that was a wild one.

Here’s a bullet-point recap of the year 2021 through the “economic lens”:

  • Continuing Covid pandemic with waves of new variants passing through the population.
  • Negative bond returns.
  • Recovering GDP and corporate earnings.
  • Highly supportive Fed and record money supply.
  • INFLATION with no end in sight.
  • US stock market leads all others.
  • An increasingly “narrow” market dominated by big cap tech companies and growth companies.
  • Small caps lag.


It was a very strong year for stock market returns (see chart below), extending the trend that began in 2019. Many market observers have been surprised by the resiliency of the US stock market, given the challenges stemming from the Covid-related shutdowns and supply chain disruptions. Indeed, the market advanced without a material drawdown during the year.

Our market commentaries throughout the year have emphasized that the strength of markets was largely the consequence of 1) extremely supportive Fed policies, 2) a strong corporate earnings recovery, and 3) an economy awash in liquidity. In our view, point number three has been responsible for a meaningful portion of the market advance as well as the high levels of inflation we are seeing. One way to assess the impact of this excess liquidity on the stock market is to look at valuation levels. The chart to the right plots the Shiller CAPE for the S&P Index dating back to the late 1800’s. The Shiller CAPE is a cyclically adjusted PE developed by Yale economics professor Robert Shiller. Looking at the right side of the chart, we can see the price the market is putting on a dollar of earnings is up dramatically since the Covid-related market sell-off in March of 2020. Moreover, stock valuation levels today exceed those experienced in the roaring 1920’s and are fast approaching the all-time high valuation levels of the late 1990s. These high valuation levels cause us to ask: what do high valuation levels usually suggest might be the experience for future stock market returns?

The chart below establishes the relationship between CAPE valuation levels and the subsequent 10-year stock market returns. The Shiller CAPE is on the X axis and the 10-year forward return is on the Y axis. Each plot shows what happened in return space for the S&P after a specific valuation level. One can see that the higher the valuation level, the lower the ensuing ten-year return.  The implications of the CAPE’s current reading of 38 for stock market returns from here is sobering (see blue arrow indicating today’s CAPE reading). Any other period where the CAPE is 38 or higher has historically resulted in well below normal stock market returns for a long time. If one were to go on this chart alone, it would be very tempting to cash out of stock holdings and go to cash. But, as is typical, it’s really not that easy.

The next chart below uses the same methodology as the preceding chart with a small change: instead of relating CAPE to ten-year forward returns, it uses one-year forward returns. One can see that, over any one-year forward period, the beginning CAPE has almost no bearing (or at least it is a very weak relationship). Given the gravity of the prior chart, the one-year chart compels a different conclusion. At current CAPE levels, one can see an equal number of positive and negative one-year forward returns, with some returns well into the +20-30% range. How do we interpret this chart relative to the preceding chart? Our interpretation is this: the market can keep running for a few more quarters, but the clock is ticking!

The implications seem fairly straightforward. For people at or near retirement, reducing some stock market exposure probably makes some sense. At the bare minimum, I’ll preface my comments by saying that investors should talk it over with their wealth advisor to determine whether changing allocations are appropriate for them because everyone’s unique situation presents different challenges and because no strategy can always assure success or protection in all markets, given their inherent volatility. Another option is to consider more defensively oriented equity strategies that seek to minimize downside equity risk. These types of strategies are available on the WealthPlan platform and can be an appropriate way to manage equity risk.

Within the WealthPlan actively managed strategies, we have been making changes at the margin to manage some of the risks associated with current market conditions. These measures include reducing exposure to high valuation securities and introducing more defensively oriented equity strategies.

2022 Outlook

It is worth noting that no person has a crystal ball and many unexpected things can and will happen. However, we can “peer around the corner” and make some educated guesses about what might transpire. Here’s my list for 2022:

  • High Inflation will continue. It is unclear whether inflation can be easily managed and the risk is that inflation will run even higher.
  • The Fed will act by becoming aggressively hawkish:
    • Speeding the taper, and
    • Increasing interest rates aggressively.
  • The housing market will slow down.
  • Corporate earnings growth will slow. Stagflation is a real possibility.
  • Market volatility will increase and we will have more selling pressure with deeper drawdowns than recently.
  • Technology and growth shares will come under pressure.
  • We may end the year down across major indexes.
  • Crypto currencies will continue to run as weaknesses of fiat currency systems becomes more apparent.
  • The US Treasury will announce the development of a digital dollar and a plan to replace currency and coin.

Thinking about an unknown future is an entertaining exercise and it is worth thinking about potential outcomes. While my predictions are admittedly dire, it is possible I’m dead wrong and we get a 2022 that looks like 2021. The bottom line is this: the long standing principles of diversification with a buy and hold approach remains appropriate for investors with long-term investment horizons (greater than ten years). As my favorite professor and colleague used to say “Diversification with buy and hold investing is the discipline of admitting your ignorance and prospering in spite of it.” No wiser words about investing have been spoken.

Erik Ogard, CFA®

Chief Investment Officer