January 18, 2022
If you wondered why the largest 500 stocks in the U.S. rallied as much as they did in 2021, I would point to the 45% profit increase of those very same companies as one major factor. According to the Wall Street Journal (WSJ), this is the largest increase in earnings since FactSet started keeping track in 2008. One of our largest holdings, the Schwab Total Stock Market – which includes the S&P 500 along with mid and small-cap names – was up 25.63% in 2021 while the Russell 2000 (mid and small company stocks) was up 14.82% and the MSCI EAFE managed an increase of 11.26%. The bond index we follow (Bloomberg US Aggregate Bond) was down 1.54% in 2021. As you can see, stocks outperformed bonds by a wide margin in 2021.
At this point one might be inclined to sell more of their bonds and purchase stocks with the proceeds. After all, to combat the historic 7% inflation we are now faced with, the Federal Reserve has said that they plan on reducing their bond purchases, or Quantitative Easing (QE), at a faster rate and they also mentioned that they would most likely raise their overnight borrowing benchmark rate to 0.75% from the current 0-0.25% rate by the end of 2022. In fact, Goldman Sachs is predicting that the Fed will increase rates by a full 1% in four ¼ point increments throughout the year. As we all know, interest rate increases mean lower bond prices. With the Fed directly controlling the short-term side of things and indirectly influencing the intermediate and longer side of bond market through their QE bond purchases, everything seems to be pointing to higher interest rates in the years to come. So the answer is yes – I believe we should tilt our portfolios a bit more towards equities in 2022. As you breakdown your allocation you will find that if you are normally 50% stocks and 50% fixed income, your actual weighting will be closer to 55% stocks and 45% fixed income. Should we sell all our bonds and go entirely into the stock market? Well, that depends upon your age, risk tolerance and financial goals among other factors. We need fixed income in our portfolios to lower the volatility so that should our stock allocation drop like it did in March of 2020, we are able to withdraw funds from our more stable bonds to meet our living expenses, to pay for tuition or to pay for an unexpected medical bill.
At this point, I would like to review different areas of our portfolio. Let us start with our fixed income holdings. By the way, depending upon the size of your portfolio, the securities you hold may differ slightly from the securities mentioned below.
Fixed Income: Our short-term bonds were slightly negative to slightly positive – depending upon which fund you look at. Our star performer was our treasury inflation protected securities (TIPS) ETF or mutual fund. TIPS were up over 5% last year, which helped our overall fixed income portfolio to a “breakeven” performance for 2021. I believe investors bid up TIPS anticipating higher inflation due to the government fiscal stimulus and the Fed’s QE program, and they now seem fully valued if not expensive. PIMCO Income also fared well – it was up 2.61%. The rest of our intermediate bonds were down a little more than 1% to a little more than breakeven. Nothing much to write home about here – except it could have been worse and I believe we could be in for a choppy bond market in the near term as the market contemplates the Fed’s next move to battle the highest inflation rate in 40 years. By the way, am I concerned about runaway inflation? While I believe the Fed should have increased the overnight rate and ended the QE program sooner, I also believe the Fed has everything in their arsenal to tamp down inflation. I just hope they don’t increase rates too drastically and tip us into a recession. If you are interested in learning more about how increasing interest rates will impact your bond funds, please review the attached Vanguard white paper.
Large-Cap Domestic Equities: If 2020 was known as the year that a handful of tech names like Amazon and Apple shot to the moon, 2021 will be known as the year everything else tried to play catch-up. I kind of felt like we had the wind at our back a bit with our largest holding up over 25% for the year. Berkshire Hathaway also rallied nicely with a +28.95% return. Vanguard Dividend Growth was up 24.84%. I’m hoping those dividend stocks will provide a bit of a buffer should the stock market suddenly decline. Our Primecap funds were a bit of a disappointment. Primecap Odyssey Growth, which many of you have, was up 18.54% while Vanguard Primecap Core was up 24.42%. These two funds concentrate on growth companies (think technology and biotech) selling at reasonable prices. They will not overpay for a company – and that helps me sleep better at night. In a stock market that is close to fully valued, there isn’t much room for error.
Mid and Small-Cap Equities: Schwab US Mid-Cap (+19.35%), Schwab US Small-Cap (+16.45%) and Vanguard TaxManaged Small Cap (+27.08%) had some nice returns in 2021 as well. Not including the total stock market allocation, the mid/small capitalization companies make up approximately 9% of our model’s stock allocation.
Foreign Equities: Vanguard Global Wellington, a 65% stock and 35% fixed income global fund, was up 13.53% in 2021. I really like this fund for its value oriented global focus, cheap expense ratio and quality management. Should the markets head south at some point, this is the fund I want to own. First Eagle (+5.25%) is along the same lines, though I have been disappointed with their latest returns. First Eagle may be too defensive – it typically shines in Bear markets, but lags in Bull markets. I view it as a hedge. We will continue to watch this fund as well as Oakmark International (+9.28%) and a relatively new addition, Vanguard International Growth (-0.74%), in the year ahead and will make changes where appropriate.
Outlook: We have a lot to worry about this year. Chief among the stock and bond market’s concerns will be the Fed policy: How much will they raise short-term rates and when? The Fed wants to tamp down the historic inflation we are seeing, and they certainly have the tools to do it. Will the inflation eventually curb car sales or will folks visit their favorite restaurant less as they start to see inflation impact their pocket book? The silver lining is that a 1% Fed funds rate is still extremely inexpensive from a historical perspective. Many of the analysts I follow are telling their clients to expect positive single digit returns in 2022. One analyst in particular, Brian Belski from BMO Harris, believes the S&P 500 will hit 5,200 – a 13% increase from the close today! I personally believe this is a ripe environment for our value holdings to do well (e.g. Berkshire Hathaway, Oakmark International, Vanguard Global Wellington) along with our dividend stock funds (e.g. Vanguard Dividend Growth). With all the uncertainty, volatile markets will return. That is where we come in. We will watch the markets and will make changes as we deem appropriate.
Enclosed you will find your Portfolio Holdings statement as of December 31, Performance Analysis and Position Performance summaries and a quarterly Account Management Fee Statement. Please contact us should you desire the most recent copy of our Form ADV Part 2A. In addition, please notify us should your investment objectives or personal financial situation change.
Thank you for being a loyal client and best wishes for a healthy and happy 2022!
- You can expect to receive your 1099-Composite and Year-End Summary by mid-February from Schwab. Your 2021 realized gains and losses as well as the total amount of management fees paid will be included in this 1099. Please let us know if you would like us to forward the 1099-Composite and Year-End Summary to your accountant.
- With the new year upon us, this is an excellent time to review your IRA and retirement account beneficiaries to make sure they are up to date. Contact us if you would like us to send you the names Schwab Institutional has on file. Also, please consider contributing to your Roth IRA if you are able. You have until April 15th to
contribute for 2021.
Best regards,
William A. Bullock