By the end of first quarter 2021, the rotation to cyclical value stocks intensified, major U.S. averages finished their fourth straight quarter higher and the 10-year U.S. Treasury yield surged 82 basis points to 1.74%. Momentum was driven by:
- The $1.9 trillion U.S. stimulus bill passed in March
- Increased retail buying
- A SPAC boom
- Strong equity flows
- Fear-of-missing-out trading behavior in cryptocurrencies and meme stocks
Continuing through much of the first half of the year, economic trends in the U.S. accelerated as COVID-19 vaccinations increased, pandemic restrictions faded and more of the world returned toward pre-pandemic activities. However, the global economic rebound remained uneven because of ongoing virus challenges, supply bottlenecks and labor shortages.
Shortly before the beginning of the second half, cyclical/value areas of the market saw their luster fade. At the time, growing fears that the Federal Reserve would let inflation run too hot and tighten policy more rapidly helped drive investors back to growth stocks late in the quarter. Cyclical areas lost additional momentum in the third quarter as economic and reopening trends slowed.
The S&P 500® Index posted a slight gain in Q3 — its sixth straight quarter with a positive return. However, three other major U.S. stock indexes ended the quarter lower. Unlike in previous quarters, and since the depths of the pandemic last year, the path of least resistance for stock prices was lower during most of Q3 — particularly in September.
Stocks also faced headwinds from an uptick in COVID-19 cases and related pandemic concerns. In addition, supply chain disruptions, transportation bottlenecks, inflation pressures, increased regulations out of China and concerns over the Federal Reserve reducing its bond purchases were other factors that weighed on investor sentiment.
Dynamics in Washington also sapped buying enthusiasm in Q3, as the path forward for fiscal stimulus became more complicated as the quarter progressed. Budget and spending debates and deep Congressional divisions on how to raise the debt ceiling contributed to the S&P 500 posting its worst September performance since 2011. An uptick in interest rates at the end of the quarter also pressured Technology.
At the close of the year, a new COVID-19 variant (Omicron), the potential for tighter central banker policies in 2022 and a slowing growth environment have given investors pause after a roughly +110% gain in the S&P 500 from the pandemic lows in March 2020.
In our view, it’s natural for markets and investors to take a pause given a still uncertain pandemic environment. However, there is room for asset prices to modestly rise next year, particularly as more of the world emerges from the pandemic. Year-to-date gains across major global stock averages, including the United States, are looking to close the year with strong gains. In several areas, stock returns are well above annual historical averages experienced in a calendar year.
As you reflect on the year and review your portfolio with your financial advisor, we believe four big-picture themes are important. Combined, these could help support stock prices next year.
- A robust economic environment should remain a tailwind for job growth next year. In our view, the labor market should continue to strengthen in 2022, particularly in areas depressed by the pandemic. More workers could slowly return to work as pandemic pressures fade, the savings rate comes down, higher wages entice people off the sidelines and activities continue to return to normal. This could be a positive for growth, spending and corporate profits next year.
- Corporate America has materially outperformed profit expectations in the first three quarters of 2021. Given investors had worried supply chain and inflation pressures would cause more companies to miss expectations, the much stronger-than-expected profit picture justifiably fueled higher stock prices in October and early November, in our view. On a historical basis, valuations remain elevated. However, given the outsized economic growth we are likely to see into next year, combined with low interest rates, easy monetary conditions and strong profit trends, the valuation appears reasonable, in our view. Companies that continue to do a solid job holding profit margins could continue to be rewarded by higher stock prices.
- Equities continue to provide opportunities for portfolio growth. In our view, tilting portfolios toward stocks and underweighting bonds this year was the single most important tactical decision investors could have made. Given strong earnings trends and elevated valuations, investors should anticipate a positive but more moderate pace of price appreciation next year. Corporate earnings could also continue to be impacted by constraints across the supply chain (ports, trucking, storage) and the availability of semiconductor chips.
- A strong economy should support the gradual reduction in Federal Reserve support. The Fed’s decision to reduce asset purchases and potentially begin raising interest rates slowly next year is because the economy can likely support more normal policies. But through much of 2022, interest rates are likely to remain low based on historical norms. Stocks tend to perform well as the Fed begins to raise interest rates, as long as the pace of rate increases are gradual. Thus, in our view, monetary policy is likely to support higher asset prices (including stocks) through at least the first half of 2022.
Given the still-strong macro backdrop, earnings growth and the potential for above-trend economic activity, we believe stocks could continue to perform well in 2022. If you have questions about your personalized investment portfolio, we encourage scheduling a review with your Ameriprise financial advisor.
Data source for indices and sector graphs: Morningstar Direct, as of Dec. 13, 2021.
These examples are shown for illustrative purposes only and are not guaranteed. Past performance is not a guarantee of future results.