I hope this newsletter finds you all doing well and staying warm. My goal is to summarize what's happening with the stock market and the economy and direct your attention to things that will help you thrive in retirement. Having a general understanding of the stock market and the cyclical nature of the economy can help keep you grounded during periods of market turbulence when your first reaction might be a flight to safety. My goal as a financial advisor is to plan ahead for bumps in the road so when they happen our best action is typically no action.
Remember that our goal is funded contentment - the ability to do what you want, when you want, with who you want, for as long as you can. History has shown that diligently saving and investing money over and beyond what we need to make us happy today, will enable us to reach funded contentment sooner rather than later. Let's jump into it!
2021 was a great year for the S&P 500 stock market index. Here are some interesting facts:
The index had a total return (including dividends) of 28.8%. This is following gains of 18% in 2020, 31% in 2019 and 22% in 2017.
Throughout 2021, the S&P 500 notched a new high every month of the year which has only happened one other time (2014).
There were a total of 70 new all-time highs which was second only to 1955's 77.
It may be hard for many to believe, but stocks actually got CHEAPER in 2021 when you look at the price of stocks, compared to how much the companies earned. Despite the S&P 500 gain of 28.8%, the earnings of these companies increased 34.5% in 2021!
What you'll appreciate is that these returns in 2021 came with very little downside volatility. The largest peak to bottom decline was -5.21%. Over the past 94 years of data, this was the 9th lowest drawdown in a calendar year.
Here are the main reasons the stock market performed so well last year:
The economy was full of demand for goods and services following the economic lock down in 2020.
U.S. consumers, on average, found themselves in the best financial position ever after paying down debt during the lockdown.
Strong demand for goods and services in addition to consumers flush with cash translated into record corporate earnings in 2021.
The Federal Reserve (Fed) pumped trillions of dollars into the economy while keeping interest rates low.
Low interest rates cause the value of future corporate earnings to be worth more, making stocks more attractive.
We were flying into 2022 and now it feels like we hit speed bump followed by a pot hole as the stock market has fell rather dramatically. From their all time highs, the S&P 500 has declined 10%, the technology heavy Nasdaq 100 index has declined 16%, and the Russell 2000 Small Cap Index has declined 20%. We can point to several reasons:
The large demand for goods and services is being met with little supply, causing prices to inflate. Inflation for 2021 was up 7% from 2021.
In an effort to tamp down inflation, the Fed is realizing they need to stop pumping money into the economy and start raising interest rates.
Rising interest rates cause the value of future corporate earnings to be worth less, so stocks become less attractive
The main reason stocks fall is because there is more selling than buying. A lot of the big moves down can come from computer algorithms that are triggered at certain levels and selling begets more selling.
No one likes volatility and lower prices, but it is par for the course when investing. Its a feature of the stock market, not an error. The only reason we receive high rates of return over the long run is because we occasionally experience losses in the short run. Risk and reward go hand in hand. No one can say for sure how far stock prices will fall in the short-term, but in my opinion there are several reasons to be optimist:
The largest factor impacting economic growth comes from consumers (70% of GDP comes from consumption) who on average are in the best financial position they've ever been.
Average household net worth is estimated to be $150,000, double the amount it was in 2007 before the financial crisis.
Another good measurement for the strength of the consumer is the amount of debt payments as a percentage of income which stands at 9% on average, the lowest its been in 40+ years.
Inflation is likely to calm down through the inherent benefits of capitalism. Demand is typically lower after the holidays which will allow time for supply of goods and services to increase.
Unemployment is declining is back down to 3.9% and the 50 year average is 6.3%.
Wage growth was 5.9% in November from a year earlier and the 50 year average is 4%. Inflation is eating into this currently, but wages are more likely to stick.
For some people I think it helps to look at historical volatility in order to know what to likely expect in the future. Below is one of favorite charts showing the intra-year declines in red and the gray bar showing where the price ended in each year going back to 1980. Throughout this period, the S&P 500 has been compounding annual at a 9.4% average rate of return. At this rate, your money doubles every 8 years.
Attempting to side step these declines (market timing) looks easy with hindsight, but is impossible to repeatedly do successfully. You could know ahead of time everything about the economy - corporate earnings, economic growth, unemployment rate...that we'd suffer a worldwide pandemic - and still not be able to accurately predict when to get in and out of the stock market. The reason is because there are 100 million investors out there that all have different expectations, time horizons, and risk tolerances.
The key to investing is to focus on your time horizon, appropriate risk tolerance, diversify accordingly, and have the discipline to stick with it. Once you have this in place, if frees you to let the market, and the historical returns it has produced, come to you.
We're here to help so please don't hesitate to reach out to myself or Ron (ron.copley@gmail.com).
I'll leave you with a quote from Warren Buffet's partner Charlie Munger who once said, "The first rule of compounding is to never interrupt it unnecessarily." For a more in depth explanation, I encourage you to read CIM's quarterly client letter by clicking the link below written by Ron Copley, PhD, CFA titled, "Volatility in the Stock Market".
In every instance when the stock market experienced steep declines, it has always been an opportune time to invest more so let's look at the contribution limits for retirement plans.
Individual Retirement Accounts The tax filing deadline for 2021 is April 18th, 2022. You have until then to max out your 2021 personal IRA contributions of $6,000 per year with an additional catch up contribution of $1,000 if you turned 50 during 2021. If you participate in an employer sponsored retirement plan you. If you make
401k Retirement Plans Individual contribution limits increased by $1,000 for a total of $20,500 per year with an additional catch up contribution of $6,500 if you turn 50 in 2022. Any company match does not impact your ability to max out these amounts.
If you own your own company and your 401k allows for profit sharing contributions, you can make an additional profit sharing contribution before you file your corporate tax return, including extensions.
SIMPLE IRA Retirement Plans Individual contribution limits increased by $500 for a total of $14,000 per year with an additional catch up contribution of $3,000 if you turn 50 in 2022.
SEP IRA Plans If you own you own business and don't have any employees, you can contribute 25% of your adjusted net earnings up to a maximum of $58,000 for 2021 up until April 15th of 2022. The limit for 2022 is $63,000.
Let me know if you are a business owner or are involved with your company's retirement plan and have questions about how it is managed and what investment options are offered. As an independent firm, we're able to customize retirement plan fund menus to include only the best and lowest costs funds options available.
