Monthly Outlook: January 2022
Goodbye 2021 and hello 2022! We’ve all heard the ancient curse, “May you live in interesting times.” Well, 2021 was interesting, at a minimum! Surely this new year will be better than the last two years and the world will get back to living “normally,” whatever that means now. But didn’t we say that a year ago? Good grief. Let’s just be thankful for what’s good in the world.
It’s tempting to make overly confident predictions for 2022 like everyone else, but I think we can do better. Based on the inaccuracy of most predictions, it’s probably more profitable to learn from history and apply the lessons to our investing strategy. I can think of three lessons that might be very timely and useful for 2022.
First, valuation is a great long-term predictor of stock market returns, but not a very good short-term predictor. One of the best valuation metrics is “Total Market Capitalization to Gross Domestic Product” (TMC/GDP). It’s better than Price to Earnings or Price to Sales. As we start 2022, TMC/GDP is at 100-year peak levels, about 3.6x. Comparing this valuation level to decades of factual data, the 10-year subsequent return for stocks from today should be about -5%/year. That’s not a typo. History tells us that this is the absolute worst time in 100 years to adopt a buy-and-hold strategy; you’ll lose money or break even at best. That’s very bad news for pensions, endowments, and stubborn, old-school financial advisors (and their individual investor clients) who believe in staying the course with their 70/30 stock/bond allocation (or whatever they have) and hoping for the best. We don’t know in advance how the markets are likely to zig and zag, but it’s a good bet that the next 10-years’ return, on average, will be flat or even negative. History lesson: Maintain a flexible asset allocation strategy. Over the next 10 years, there will be times to be fully invested for growth, but there will be downtrends and the need for protection.
Second, the best short-term indicator for market returns is momentum, or price trend. That is, a market in motion tends to stay in motion until it meets an opposing force, to paraphrase Isaac Newton. We use the 200-day moving average as our primary determinant of price trend. Many other investors use this 200-day moving average trendline, too, which is partly why it works so well. If any holding (any stock, bond, or commodity index fund) is above its 200-day moving average, we say it is up-trending and should be bought and held to capture growth. Regardless of valuation, economic indicators, political outcomes, or anything else, the trend will continue until it doesn’t. Conversely, any holding that is trading below its trendline should be sold or trimmed to protect from significant loss. History lesson: Use price trends to inform you when to be fully invested and when to be protective. We don’t need to predict inflation, economics, or politics. It’s all embedded in the factual price trend.
Third, last year’s winners are rarely next year’s winners. You’ve probably seen the multi-colored charts with lots of squares for each asset class like “US Large Growth,” “Bonds,” “Commodities,” and so on sorted by year. Sometimes they’re called market “quilts” or “periodic charts.” You can find one example here. For the past three years, US Large Growth (mostly tech including Microsoft, Apple, Google, Tesla) has crushed it with huge returns of 30%+/year while other asset classes were flat or even negative. History tells us that it is highly unlikely that US Large Growth will be the best in 2022. While US Large Growth remains up-trending as we start 2022, we will continue to hold for growth (see Lesson #2). However, a four-peat is rare and we should be ready for a change. Perhaps INTL Value, Commodities, Bonds, or even Cash, will be at the top of the chart next year. Predicting the best asset class for 2022 is nearly impossible, but history tells us that we can be confident that US Large Growth will not be the best. History lesson: Monitor the relative performance of different asset classes and tilt your portfolio toward what’s working best. Stay flexible.
2022 will surely bring more “interesting times” but we don’t have to know how, in advance. The news will focus on inflation, COVID, mid-term elections, and stimulus plans. We’ll focus on valuation, price trends, and relative asset class performance to manage portfolios with a goal of capturing the most return possible, safely. Happy New Year to all!