Takeaways & Key Expectations

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février 14, 2022

Equity Market Commentary - February 2022

Takeaways & Key Expectations

Equity Market Commentary - February 2022

février 14, 2022

The US Equity Market:

Seems to me what’s transpired year-to-date is a microcosm of what’s to come for the year. It’s a close battle between the positives and negatives.
The equity market convulsed when we heard from Fed Chair Jerome Powell in January. His decidedly more hawkish tone sent shivers through the equity markets. Remember, at this stage of an economic recovery, it is not that unusual for the Federal Reserve to begin shifting policy and reducing liquidity. Tightening financial conditions weigh on equities, especially the more speculative stocks.
However, the fourth quarter earnings reports for corporate America was good news overall. Clearly the earnings misses get the headlines, nevertheless, consensus earnings estimates for the S&P 500 for 2021, 2022 and 2023 are higher today than they were at the end of 2021.¹ Overall, corporate America is healthier than Wall Street has expected.² Throw in the resumption of strong company stock buybacks, and there is your good news for stocks.
Seems to me, this battle might be with us for most of the year. As I have articulated, this type of environment is not unusual for the third year of an economic recovery. In the end, Applied Equity Advisors believes 2022 will be an ‘ok’ year for the market return overall, just not as strong as what we’ve seen the last few.³
Despite lower returns, 2022 will offer more opportunities for tactical alpha generation at the allocation level. We’ve already seen this. By the third week of January, the market seemed completely focused on the bad news and had dropped over 10% peak to trough. That offered a buying opportunity, as shortly thereafter the market recovered on strong earnings reports.

Don’t let the bears scare you out of taking advantage of the selloffs, and, likewise, don’ chase when there is too much market strength.* We believe it should be a ‘reversion to the mean’ type year.

AEA Style Positioning:

We remain committed to a value bias in the US, for two reasons:
1. Value stocks are always cheaper, but in recessions they get very cheap. Post recessions, they trade back to a normalized level. They are not at that level yet.⁴
2. We think the economy could be moving into a period of permanent higher inflation. More like the 1960s…higher growth/higher inflation, the antithesis of the period of 2010- 2019. In that environment, we think inflation-sensitive stocks, which reside in the value bucket, could outperform for an extended period.
However, we are less negative on growth than we have been, given the magnitude of underperformance of growth stocks. As we have discussed, in many ways the chase into growth/technology stocks post the COVID lows reminded us of the NASDAQ bubble of 2000. We felt that the uber growth stocks were trading at the same levels of extreme valuation.⁵ Once the bubble pricked it was going to be ugly, which it has been.⁶

However, the more established mega-cap technology stocks never traded to the same frenzied level. That is how the environment today is different than it was in the year 2000.

Recent underperformance despite numerous impressive earnings reports means many of these large-cap growth names are now trading at very reasonable valuations. We would NOT recommend selling growth here.

3. The one group that continues to appear expensive to us are the defensive stocks.⁷ Bull markets don’t tend to end with investors willing to pay such premiums for relative safety.

AEA Geographic Positioning:

1. We regularly hear the calls from strategists that this will finally be the year to favor Europe over the US. It is true that Europe is cheaper and has more of a value bias. However, it’s one thing to make broad general calls like this and yet another to actually pull the trigger and reallocate assets out of the US to Europe.

Simply put, as an investor would you be comfortable selling Berkshire Hathaway, the largest US financial, to buy HSBC, the largest European financial? Would you sell Adobe to buy SAP or Amazon to buy Siemens?⁸We certainly find some European stocks attractive, but I question jettisoning superior-performing companies for lesser ones, just because “they are cheaper”.⁹

2. The region of the world that has seen companies compound at rates competitive with great US companies is Asia ex-Japan.¹⁰ While that region woefully lagged in 2021, causing a drag on our performance for our global strategies, we continue to believe this is a better allocation for non-US assets than in Europe (or Japan for that matter).

Simply put, we believe finding great companies that are temporarily out of favor a far more enduring strategy than investing in laggard companies, hopeful that better results are to come.

¹On December 31st, 2021, the consensus estimates, according to Factset, for 2021, 2022 and 2023 were $204.95, $223.46 and $245.01. As of February 10, 2022, they are $207.79, $224.89, and $247.53.

² The bears love to point out that “the earnings revision ratio is peaking”. I have heard this doomsday call since early last year, but the positive earnings beats simply continue. To me, looking at the second derivative of earnings reports and trying to project the future is dubious. It’s like saying that the Golden State Warriors are having a bad year, because while they have the second-best record in the NBA, they are not “winning by the same percentage as last year”. A win is a win, just like an earnings beat is an earnings beat.

³ A high single-digit returning year would be historically consistent with the third year off the mid-recession bear market low. While I am not a strategist and don’t regularly set price targets for the S&P 500, a 5,100 year-end S&P 500 would imply an approximate 8.1% total return for the year off a 4,779 start to 2022.

4 While value stocks have certainly done well recently, as they did in the second half of 2020, they did not outperform in 2021, as measured by Russell Growth compared to Russell Value indexes. Bloomberg.

⁵The fifty fastest growing stocks in the Russell 1000 traded to an even higher valuation in 2021 than they had at the NASDAQ peak in 2000. Factset.

⁶At its low in late January, the ARK Innovation ETF was off -57% from its high. Bloomberg.

⁷ The earnings stability factor, a measure of defensive earnings resilience, now trades at two standard deviations expensive relative to where it has traded for the past 26 years.

⁸ For example only. None of these securities are owned in AEA active strategies.

⁹ As of this writing, Berkshire Hathaway has compounded at a 15.06% annualized return for the last decade. HSBC is only at 3.17%. Adobe has compounded at 31.90%, while SAP at 8.75%. Amazon has compounded at 33.05% while Siemens at 8.75%. As measured in US dollars. Bloomberg.

¹⁰ From 2010-2020, the three largest stocks in the MSCI Asia ex Japan Index compounded at an average annualized return of 25.77%. In 2021, they returned -5.61% on average. Bloomberg.

^* At the low of January 27, 2022, the SPX was off 10% from the high. At that level, a year-end target of 5,100 offered 18% upside. But at the high on January 3rd of 4,797, there was only 6% upside to 5,100.

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Andrew Slimmon

Head of Applied Equity Advisors Team

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