As we wrap up 2021, stocks have had a good year. With just over two weeks to go, the S&P 500 has advanced more than 20%, but the action under the surface has not been quite so strong. More than 90% of index constituents have experienced a greater than 10% decline from peak, and a significant proportion of the index’s strong performance, particularly in the second half of the year, has been driven by the ten largest stocks.
Headline returns have been helped by the faster-than-expected snapback from the pandemic reflected by strong corporate earnings. Overall earnings for the S&P 500 in 2021 are expected to increase approximately 45%, helped by easy comparisons from a year ago. Looking ahead to 2022, consensus projections are for solid earnings growth of 9%. The current forward P/E on the S&P 500 is approximately 21x, elevated relative to history but at least partly justified by the low interest rate environment.
The question is what happens to rates as major central banks begin to pull back on the liquidity that has supported financial markets since the start of the pandemic? If rates remain low and projected earnings growth comes to fruition, favorable conditions remain for stocks to perform well.
Things become more challenging if rates materially increase, pressuring multiples. This is especially true for high-flying growth stocks where meaningful cash generation isn’t anticipated until well into the future. Though monetary policy is likely to tighten, the anticipated slow pace at which it does so would help the market digest this headwind.
As we move into 2022 there is greater uncertainty, but the prescription remains the same. A long-term plan that includes ownership of reasonably valued, growing companies generating free cash flow--like the companies profiled in each monthly issue of the Investor Advisory Service newsletter--is an important component of long-term investment success.
Reprinted from the January 2022 issue of the Investor Advisory Service. For more information, to download a sample issue, or to subscribe to the best investing newsletter in the U.S. for long-term consistent returns, visit Investor Advisory Service.