Looking back at 2021, there was a lot to digest. To call it a roller-coaster would be an understatement. From political insanity to start the year south of the border, to a successful vaccine rollout and a hopeful reopening, emotions ran across all ends of the spectrum. With that said, equity markets continued to perform well as they looked forward to the end of the pandemic - and then came the 4th quarter. The emergence of a new variant brought disappointment to so many ready to get on with their lives in a post pandemic world.
With the emergence of a highly contagious Omicron variant, investors shifted their focus from economic re-opening back to purchasing technology shares which had performed well in the early days of the pandemic. Perversely, new lockdowns were being considered as bullish for these stocks as it meant more artificial support in the form of stimulus and low rates. Against this backdrop, however, was a decidedly different tone from central banks around the world - particularly in the US. Fed Chair Jerome Powell not only indicated that the time to unwind stimulus was coming, but that this would move forward despite a resurgent virus.
The concept of “transitory” inflation was abandoned - given stellar economic performance and incredibly high inflation not seen for over 30 years. So, while the old pandemic playbook was returning to fashion in the 4th quarter, a second trend continued in the form of higher rates, with shorter term rates in particular catching up to longer term rates which had already moved considerably higher. From an investment perspective, this is positive for financials which had previously suffered from lower interest rates. Balance sheets, dividends and valuations in this group remain very attractive and higher rates will only help this.
What will be key to watch over the coming year is the degree of inflation being felt by consumers and businesses, and the corresponding path of interest rate increases. Longer term bonds will remain a difficult investment as rising rates disproportionately hurt their values. While banks will benefit from a rising rate environment and re-opening economies, certain sectors will be especially hurt, i.e., the technology sector.
Given some technology shares’ very lofty valuations, the only way to justify their current prices is by valuing cash flows up to 10 years out. This is especially difficult in a sector where technological change is inherent, and 10 years can represent an eternity. Some companies will still be successful, but many will evaporate. As interest rates begin to rise, these stocks with high valuations are most at risk. This is because investors will begin to value predictable near-term earnings over very distant (and accordingly uncertain) long term earnings. Growth for every business declines at some point. Markets eventually realize this as well.
Admittedly though, the market is not always considering fundamentals and valuations in the short term. We have seen a considerable herd mentality take hold over the last few years. Market concentration is at an all time high with technology shares approaching 40% of the S&P500. Only five technology stocks make up almost one quarter of the S&P500 with some of their valuations climbing beyond reason. Below the surface of these behemoths is a universe of speculative investments whose investment thesis is more about hope bordering on religion than any legitimate analysis. Investors should remember it took almost 14 years for the Nasdaq to recover its peak in 2000, with many of these “concept” stocks no longer in existence.
Looking forward to 2022, Covid remains on the radar as countries look to further stem the tide of infections. Crucially, it appears that vaccines and boosters are working, and severity of illness is well below previous iterations. Unfortunately, the sheer scale of infections could put pressure on staffing levels for front line workers, particularly in school and health care settings. Against this backdrop, and after a good year in markets, investors should be prepared for some volatility in the short term.
Looking beyond the short term of the next six to twelve months, we remain very constructive on the opportunities for equities, particularly in higher quality companies with reasonable valuations. Value exists, particularly in areas such as healthcare and industrials, where traditional companies blur into technology ones with a focus on telehealth and automation, as well as building out infrastructure for a “greener” energy complex. Dividends will be an ever more important component of investors’ total return and we are well placed in that regard - investing in companies with solid balance sheets and predictable cash flows that can support and grow those dividends. And as always, we will not hesitate to trim any holdings whose valuations appear stretched, and will take advantage of any opportunities in a broader selloff.
We thank you for the confidence you have placed in us, and wish you and your loved ones a happy and healthy 2022.
Doherty & Associates
With the emergence of a highly contagious Omicron variant, investors shifted their focus from economic re-opening back to purchasing technology shares which had performed well in the early days of the pandemic. Perversely, new lockdowns were being considered as bullish for these stocks as it meant more artificial support in the form of stimulus and low rates. Against this backdrop, however, was a decidedly different tone from central banks around the world - particularly in the US. Fed Chair Jerome Powell not only indicated that the time to unwind stimulus was coming, but that this would move forward despite a resurgent virus.
The concept of “transitory” inflation was abandoned - given stellar economic performance and incredibly high inflation not seen for over 30 years. So, while the old pandemic playbook was returning to fashion in the 4th quarter, a second trend continued in the form of higher rates, with shorter term rates in particular catching up to longer term rates which had already moved considerably higher. From an investment perspective, this is positive for financials which had previously suffered from lower interest rates. Balance sheets, dividends and valuations in this group remain very attractive and higher rates will only help this.
What will be key to watch over the coming year is the degree of inflation being felt by consumers and businesses, and the corresponding path of interest rate increases. Longer term bonds will remain a difficult investment as rising rates disproportionately hurt their values. While banks will benefit from a rising rate environment and re-opening economies, certain sectors will be especially hurt, i.e., the technology sector.
Given some technology shares’ very lofty valuations, the only way to justify their current prices is by valuing cash flows up to 10 years out. This is especially difficult in a sector where technological change is inherent, and 10 years can represent an eternity. Some companies will still be successful, but many will evaporate. As interest rates begin to rise, these stocks with high valuations are most at risk. This is because investors will begin to value predictable near-term earnings over very distant (and accordingly uncertain) long term earnings. Growth for every business declines at some point. Markets eventually realize this as well.
Admittedly though, the market is not always considering fundamentals and valuations in the short term. We have seen a considerable herd mentality take hold over the last few years. Market concentration is at an all time high with technology shares approaching 40% of the S&P500. Only five technology stocks make up almost one quarter of the S&P500 with some of their valuations climbing beyond reason. Below the surface of these behemoths is a universe of speculative investments whose investment thesis is more about hope bordering on religion than any legitimate analysis. Investors should remember it took almost 14 years for the Nasdaq to recover its peak in 2000, with many of these “concept” stocks no longer in existence.
Looking forward to 2022, Covid remains on the radar as countries look to further stem the tide of infections. Crucially, it appears that vaccines and boosters are working, and severity of illness is well below previous iterations. Unfortunately, the sheer scale of infections could put pressure on staffing levels for front line workers, particularly in school and health care settings. Against this backdrop, and after a good year in markets, investors should be prepared for some volatility in the short term.
Looking beyond the short term of the next six to twelve months, we remain very constructive on the opportunities for equities, particularly in higher quality companies with reasonable valuations. Value exists, particularly in areas such as healthcare and industrials, where traditional companies blur into technology ones with a focus on telehealth and automation, as well as building out infrastructure for a “greener” energy complex. Dividends will be an ever more important component of investors’ total return and we are well placed in that regard - investing in companies with solid balance sheets and predictable cash flows that can support and grow those dividends. And as always, we will not hesitate to trim any holdings whose valuations appear stretched, and will take advantage of any opportunities in a broader selloff.
We thank you for the confidence you have placed in us, and wish you and your loved ones a happy and healthy 2022.
Doherty & Associates