APW Investment Committee Q1 2022 Commentary
Q4 2021 Review
The fourth quarter of 2021 saw a sharp dispersion in global equity market performance with large US companies strongly outperforming every other market and asset class. This continued a long-term trend in US and S&P 500 specific outperformance.
The largest economic story of the quarter was the surge in inflation as the headline CPI rate spiraled upward recording a reading of 6.22% in October, 6.81% in November, and 7.04% in December. These are the highest monthly readings since 1982. This was enough of a concern to cause the Federal Reserve to accelerate the reduction of bond purchases (“the taper”) it had started in November. Most major banks are estimating the Federal Reserve will raise the Federal Funds rate 3-4 times this calendar year.
US interest rates overall have started to drift higher with the US 10 year Treasury Note interest rate up to 1.78% as of Jan 17, 2022 quarter from 1.48% on October 1, 2021. The US dollar index continued its slow and steady climb ending the year at 95.67.
Austin Private Wealth Model Changes
As we discussed last quarter, while a number of factors leading to the current inflation spike appear to already be reversing, we see two important areas which are likely to be sticky in 2022: wages and home prices.
Wages are likely to continue to rise simply because the number of unemployed workers is significantly smaller than the total number of job openings – an unusual economic condition to be sure and one that won’t resolve quickly.
In the case of home prices, the significant underbuilding of US single family homes in the period following the great financial crisis, coupled with the supply chain and construction worker shortages will likely prolong the pressure on home prices. This is best illustrated by a housing trends chart published recently by Blair duQuesnay CFA®, CFP® which takes the US population and divides it by US housing inventory over time. Essentially the number of Americans per available home (US inventory) has almost quadrupled since 2005. While slowly rising interest rates may put some headwinds in place, they are unlikely to derail what is effectively a structural deficit in US housing supply.
With inflation likely to stay at elevated levels in 2022 (even if it comes down somewhat from the current range) and the Federal Reserve beginning a liquidity tightening cycle, the main hope for equity markets is continued strong earnings growth. Q4 2021 earnings season is about to begin and should provide a good indication of the outlook for 2022 as companies have had to battle the massive spike in Omicron through the quarter. Strong results in the face of the pandemic headwinds would bode well for the relief health experts predict (hope for?) starting in Q2 and beyond.
One can view the 10 year US Treasury rate rise over the past 6 months from 1.19% in July to 1.78% in January as either small in absolute terms (roughly 60 basis points) or seismic in percentage terms (a 50% increase). Either way, the US equity markets have already started to react. While the S&P 500 index overall is up a bit over 7% since the July rate low, many high earning and sales multiple stocks, particularly those names that were very strong in the early days of the pandemic are distinctly in bear market territory (20%+ losses) with some down more than 50%. Here are a few examples.
Source: Ycharts 1/17/2022
We think this trend is likely to continue as many of these companies have little to no earnings and, even now, historically high price to sales multiples.
As the growth opportunities start to dwindle in US high growth equities, we expect to see some assets redirect to other regions where pockets of high growth exist. We continue to see significant and increasing relative value in international markets generally and in emerging markets particularly - the worst performing major index in 2021.
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