Stocks ended the year in a show of strength, establishing a new record weekly close, one day after setting a record daily close. Last week, the S&P 500® index rose 0.9 percent, and for the month of December rose 4.4 percent. For the full year, the S&P 500® index surged higher by 26.9 percent. But it may be worth noting that the strongest groups recently have mostly defensive sectors, as investors weigh concerns related to the pandemic, evolving monetary policy, and an aging bull market. The leaders last week were Real Estate, Materials, and Utilities. Only Communication Services was lower, but Technology, Consumer Discretionary, and Financials all underperformed. For the month, Consumer Staples, Real Estate, and Utilities led the way. No sectors were lower, although in a statistical anomaly, the Consumer Discretionary ETF XLY was exactly unchanged. But other underperformers included Energy, Financials, and Tech. For the full-year, energy stocks led the way higher with a gain of 46 percent, followed closely by the 42 percent gain in Real Estate. The underperformers were led by 14 percent gains in Utilities and Consumer Staples.  

The last three years have seen a string of impressive gains, with the S&P 500 rising 16 percent in 2020 and 29 percent in 2019, resulting in a three-year gain of 90 percent. Interestingly, since the -38 percent return in 2008 during the financial crisis, the S&P 500 has suffered only three down years, with an average decline of just 2.3 percent. And in that time the index has delivered a price gain of 428 percent, with an average annual gain of 13.6 percent.

Based on Bloomberg estimated earnings, the S&P 500 ended the year with a trailing twelve-month price/earnings (p/e) ratio of 22.8X, down from the 30.7X  where it ended 2020, but still elevated. Once fourth quarter earnings are included, earnings for 2021 are expected to have grown by an eye-opening 45 percent. The index is currently trading at a 2022 estimated p/e of 21.1X, little changed as the market’s price advance has kept pace with the growth in earnings. This year, earnings are forecast to grow by 9 percent. More immediately, fourth quarter earnings season is fast approaching, and earnings are expected to rise 21 percent.  

Bond Prices Under Pressure as the Fed’s Policy Shifts 

Bond prices came under some modest pressure as the year drew to a close, as the Federal Reserve accelerated its shift toward a less accommodative policy stance. During December, the yield on the ten-year Treasury note rose modestly to 1.51 percent from 1.44 at the end of November. The shorter end of the curve rose more sharply, climbing to 0.73 percent at year end from 0.53 percent at the end of November, resulting in the flattest Treasury curve of the year at 77 basis points. For December, the Bloomberg Barclays U.S. Treasury index fell 0.5 percent, and fell 2.3 percent for the full year. High yield corporate bonds, on the other hand, took their cue in December from the strong economy. Spreads relative to government bonds, which had spiked following the announced presence of the Omicron variant in late November, narrowed sharply to 310 basis points at year-end compared to 367 at the start of December, based on the ICE Bank of America High Yield Master II index, leaving the spread just fractionally above its tightest level in ten years at 301 basis point, established earlier last week on Tuesday. For December, the Bloomberg Barclays U.S. High Yield Corporate index rose 1.9 percent, and 5.3 percent for the year.

The dollar was little changed in December, but for the full-year the DXY index climbed 6.4 percent. The Bloomberg Commodity index climbed 27 for the year, including a 3.5 percent gain in December. West Texas Intermediate crude oil began the year at $48.52 a barrel, but ended at $75.21, a 55 percent increase.

Foreign Equity Markets Ended The Year on a Strong Note

The EuroStoxx 50 index climbed 1.0 percent for the week, and 5.8 percent for December. The full-year euro-denominated gain of 21 percent trailed the U.S., and in dollar terms the full-year gain slipped to just 12.7 percent. The MSCI EAFE index delivered a dollar-based price-only return of just 8.7 percent, restrained by negative dollar-denominated returns in Japan. Emerging markets also suffered full-year losses in dollar terms, as the MSCI EM index fell 4.6 percent, despite posting a gain of 1.6 percent in December. The MSCI Latin America sub-index surged 4.6 percent in December but needed a lot more than that to offset its full-year dollar-based loss of 13.1 percent. The MSCI Asia ex-Japan index rose 1.2 percent in December, but slipped 6.4 percent for the year.

Market Predictions for 2022: Moving from Extraordinary to Ordinary

Equity returns in the year ahead are anticipated to be more modest than last year, but positive nonetheless. Continued strong economic and solid earnings growth, and moderating inflationary pressure should create a favorable environment for further modest gains. Our base-case year-end forecast for the S&P 500 is 4950, implying a slim 3.8 percent return, trimmed in part by the gains of the past two weeks.

Our more favorable scenario target of 5300 would result in a gain of 11.2 percent. Bond yields, however, are expected to come under further upward pressure, with the ten-year yield trending toward 2.0 percent, suggesting uninspiring returns from Treasuries. This is also an election year, which historically results in somewhat higher volatility as summer approaches. Of course, much will depend on the continued path of the pandemic. For now, year-end market strength is implying that the Omicron variant will be less economically disruptive than the Delta variant. But, of course, that remains to be seen.  

In the days immediately ahead, before the start of earnings season, the economic calendar rolls along. This week is headlined by the December jobs report, which is expected to show the creation of 400,000 new non-farm jobs, and a further downtick in unemployment to 4.1 percent. Also scheduled are the December ISM PMIs, which are expected to show some moderation, while remaining at healthy levels of activity. Of particular interest will be the minutes of the December Fed meeting, during which it accelerated its bond taper and projected three rate hikes this year.

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