2021 was the sixth-best year for US equities since 1990. The S&P 500 gained 26.9% while the Dow Jones Industrial Average and the NASDAQ Composite gained 18.7% and 21.4%, respectively.
Bonds ended the year lower with the Barclays Aggregate Composite declining 1.77%.
Following is an overview of key events in 2021 and an outlook for 2022.
A Strong Year with Low Volatility
Volatility was very low in 2021 despite headlines that included an attack on the Capitol, historically high inflation, supply chain disruptions, multiple correction forecasts, and two new COVID-19 variants; this didn’t deter US stocks from making all-time highs.
- The S&P 500 recorded 70 all-time highs in 2021, a record second only to 1995
- The S&P 500 maximum intra-year drawdown was only 5%, markedly lower than the average which is closer to 11%
New Market Speculators
Excess liquidity in the system brought speculation to the market. 2021 began with a new breed of market participants commencing a speculative form of trading as amateur investors used social media to drive up company shares that hedge-fund professionals were shorting.
Video game retailer GameStop (GME) gained as much as 1,700% and AMC Entertainment Holdings (AMC) surged more than 800% in January alone. Both stocks are well off their highs for the year but closed 2021 above where they started.
Some investors rushed into special purpose acquisition company (SPAC) deals in 2021, which allow private companies to go public without the lengthy IPO process.
This part of the market also became quite heated early in 2021, but most of these SPAC prices abated by year’s end.
- There were pockets of speculation during 2021, but the overall market didn’t see excess exuberance.
- In fact, the number of stocks participating in the index returns faded into the latter part of the year. Early 2021 saw upwards of 90% of constituents in the S&P 500 trading above their 200-day average, but that fell below 60% as the year continued.
- By year-end, just five stocks—Microsoft (MSFT), Google (GOOG), Apple (AAPL), Nvidia (NVDA) and Tesla (TSLA), accounted for 51% of the S&P 500’s return since April.
The Market Valuation
Steady upward earnings revisions supported market gains throughout the year. Despite a nearly 27% rise in the S&P 500 Index, the index price-to-earnings fell as earnings rose faster than stock prices.
Though the index multiple remains elevated at 21.1 times versus the 25-year average of 16.8 times, it may not be unwarranted considering the underlying strength of the economic outlook.
Considerations for 2022
Some market dynamics have shifted, but there are many reasons to continue being constructive on equities.
Labor market recovery has been notable. The United States added 18.5 million nonfarm jobs since April 2020, with new unemployment claims reaching a 52-year low.
Rising wages in a tight labor market could challenge corporate margins, but strong household balance sheets and pent-up demand-for-services should bode well for consumer consumption, which makes up 70% of gross domestic product (GDP).
Corporate Balance Sheets
Corporate balance sheets are strong and will likely support healthy capex spending and productivity trends into 2022. Business investment recovered faster than global growth in 2021 and more significantly than in recent downturns.
If new capital investment embodies greater technological advancement, then productivity could be boosted, further lessening inflationary pressures and allowing continued growth. Private sector demand could be sufficient to keep the economy growing above trend.
Inflation will likely continue into early 2022, though signs show that inflation may be peaking. Supply chain issues that fueled inflation look set to dissipate in the second half of 2022.
Recent wage growth could boost participation rates making rising labor costs more of a level shift than a persistent trend.
This improving productivity trend could allow firms to absorb higher wage costs, which could dampen some of the inflationary pressures seen in the second half of 2021.
The Federal Reserve kept interest rates near zero throughout 2021 and continued their asset purchase plan adding liquidity to the markets each month, which encouraged consumption and likely exacerbated COVID-led supply bottle necks contributing to inflation.
The Federal Reserve also announced plans to begin tapering its monthly bond-buying program in November, suggesting the program will be eliminated by March 2022. Policymakers also indicated plans to increase the federal funding rate, potentially as many as three times in the new year to temper inflation.
Pivoting from easy monetary policy to a tightening bias has historically created volatility in the markets, but this change being widely communicated could mean fewer bumps than previous periods of federal tightening.