2022 Market Review & Outlook

As promised, the article to follow is a written version (and also slightly different from the video version) of the “2022 Market Outlook Screencast,” which can be watched by CLICKING HERE.

Due to the heavy content contained within this article, comments will be kept as concise as possible, allowing for a more “picture and chart-heavy” presentation.  As the old saying goes, “A picture speaks a thousand words,” so I’m going to fight my typical urge to over-do the typing.

First off, let’s talk about what happened in 2021…

My good friend and portfolio manager, Andrew Thrasher, stated that “It’s not normal to see the market less than 2% from a high, while the typical stock is down -12%; but there’s hardly anything normal about today’s market environment.”

Mark Minervini, one of the top stock traders of all time, stated the following in December: “I would describe the trading in 2021 in two words… no legs.  Some stocks made nice moves, but this is probably the most bifurcated market I have ever seen in my 38 years of trading.  You have a list of stocks that are down -40 – 80%, but the S&P500 is less than 1% from its high.”

Bottom line, the major market indices (such as the S&P500 or the Dow) disguised an extremely difficult stock market throughout 2021.

Take, for instance, the fact that only 25 of the stocks within the S&P500 accounted for 40% of its “weight.”  For those who don’t know, there are 505 stocks on the S&P500, so when 25 of those stocks account for 40% of its movement, the metaphorical tail is wagging the dog.

Here are some other, notable bullet-points on 2021’s tough market:

• At one point in December, only 26.34% of stocks were within 10% of their highs, which means that almost ¾ of stocks were down more than -10%
• Around the same timeframe, 41.55% of stocks were trading down more than -20% below their highs.
• Almost 10% of stocks were hitting new 52-week lows in early December, which was the worst observed since the COVID crash.
• Bonds were down in value for only the 4^th time in 45 years.
• The average Russell 3000 stock (which accounts for almost every investable stock in the U.S.) was down -50% at one point toward the end of 2021.

I mentioned earlier that 25 of the stocks on the S&P500 accounted for 40% of its “weight.”  Check this table out below… which shows that the top 5 holdings on the S&P500 accounted for 23.5% of its weight (almost ¼!) in 2021!

If that’s not mind-blowing, take a look at this next one.  Toward the end of 2021, the top-30 stocks on the S&P500 accounted for 73% of the prior 3-month return for the index.

Here’s a similar story, but a different index.  This time, we’re looking at the NASDAQ on the left, with and without its 5 biggest stocks.  Notice the stark difference in results.  On the right is a quote by Cathie Wood, one of the top portfolio managers in the country, whose portfolios were down almost -40% in 2021.  While I don’t agree with the comment in the post (that Cathie is lying or forgetful), the point remains the same – that “the stocks within the stock market” had a rough year in 2021

Here’s another table (below) that shows what a tough time stocks had beneath the surface in 2021:

I’m a longtime subscriber to Lowry Research, which is the oldest technical analysis research firm in the U.S., and they have a proprietary indicator that separates buying power from selling pressure within the market.  Simply put, when there is a lot of buying enthusiasm, buying power rises.  When there isn’t, it falls.  Similarly speaking, when there is a lot of selling enthusiasm in the market, selling pressure rises.  When there isn’t, it falls.

In the screenshot I took of the December 30^th chart, you can see the following:

• Buying power stopped rising in early February and fell throughout the majority of 2021
• Selling pressure generally rose throughout the year.
• The two crisscrossed several times (which is not normal) throughout the last half of the year.

Probably one of the biggest problems with 2021 was the chop-fest experienced in small company stocks.  Aside from the rampant volatility seen below, imagine trying to catch a trend in this mess.

At the end of the year, I ran two relative strength (RS) comparisons… one that compared mid-size company stocks vs. the S&P500 and another one that showed the same relationship with small-size company stocks.  This first one is mid-caps – notice the lower-lows and lower-highs:

…and here is the small-cap RS chart, below.  Again, notice the “trend” as you step back and scan out:

A few stocks did well in 2021.  Stocks like Apple:

However, it was much easier to find stocks that did NOT do well, such as Cathie Wood’s ARK Innovation Portfolio:

…or Investors Business Daily’s “top-50 Growth Stocks in the U.S.”

…or Zoom Video Communications, which was thought to be such a great stock, given the “work from home” world we’re all living in today:

You’d think that, in this world of modern medicine, vaccines, and booster shots, Biotechnology would be booming right along with its healthcare cousins… but nope:

…and to think that the U.S. is still better on a relative basis – take a look at Chinese internet stocks in 2021:

If all that wasn’t enough, long-term, high-quality corporate bonds were down in 2021 as well:

Here’s a different look at the bond market:  The chart below is the 20-year U.S. Treasury Bond…

To wrap up our coverage on bonds in 2021, here’s a snapshot of the bond market as a whole, as represented by the U.S. Aggregate Bond Index ETF:

That was a lot of charts and tables, so let’s pause for a moment…

2021 was a year of what we call “rotation,” where strength within the market’s surface changed leaders several times throughout the year, causing the choppiness and declines beneath the surface of the S&P500, Dow, and NASDAQ indices.

What about this year?  What are some things we should be on the lookout for?

• Potential health issues with President Biden as his term progresses
• Geopolitical problems, such as military conflicts in places like Taiwan, Ukraine, etc.
• The Federal government goes after “big tech” and consumer confidence starts to wane
• Oil prices continue to surge, adding fuel (pun intended) to inflationary fire, all while putting economic pressure on the consumer.

Why might stocks struggle in 2022?

• More COVID variants and subsequent surges thereafter
• Continued supply chain shortages and bottlenecks in the economy
• Continued labor shortages in many sectors
• Jerome Powell and The Fed raise rates too much, too fast, or both
• Bumpiness in the market, in anticipation of the 2022 midterm elections in November.

Why might stocks flourish?!

• COVID symptoms and mortality improves with each new variant
• Inflation calms down and the supply chain eases, allowing for more efficient economic growth
• Improved labor market throughout the year
• Jerome Powell and The Fed raise rates “as expected,” and no more (or better yet… less!)
• The midterm election uncertainty eventually and inevitably passes

When we look back in history – all the way back to 1946 – and observe all the midterm election years, the seasonal trends play out like this (see chart below):

1. The market tends to struggle for the first six weeks of the year (or so)
2. Stocks gain traction between mid-February and mid-April
3. A decline and/or sideways movement in the market tends to unfold between May and the midterm elections,
4. After which, stocks tend to rise into year-end, after the “election uncertainty” has passed

Now, just because seasonal averages play out this way doesn’t mean that 2022 has to unfold in precisely the same fashion.  If the market follows these averages, then we’ll get what we expect with very little new information.  However, if the market bucks these seasonal trends and acts in a different manner, this is something we’ll want to pay close attention to as the year unfolds.

As I finish writing this “written version” of our Market Outlook this year, even the biggest stocks that “wag the dog” have been struggling this year.  In other words, we’re getting a very normal, run-of-the-mill correction in the market, which is just that – normal and healthy.

Assuming the correction doesn’t develop into something worse (which we’ll be watching), there will be opportunities on the other side.  For now, the assumption is that we’ll have a relatively volatile, choppy and flat first half of the year with the midterm election paving the way for what we hope will be a tailwind into year-end.

My next update will take place at our first Quarterly Scouting Report, which I will record during the 1^st week of April.

‘till next time!

Adam