Four items for your consideration today, still in our holiday week-shortened report format:
#1: With the S&P 500 up 27.6 pct year-to-date and just 4 trading days left in 2021, what can investors expect for January 2022? History shows the January after a strong year can be a mixed bag. Here is the data:
#1: Since 1980, when the S&P 500 has a +20 pct total return in a given year, the January of the following year is – on average – almost exactly flat (-0.09 pct mean price return). Whether the index was positive in January was a coin flip, up 8 in years and down in 8 years. The worst return was -6.9 pct in January 1990 and the best was +6.1 pct in January 1997.
Focusing on just the first 5 trading days of January after a robust year for the S&P, the index gains 72 basis points on average. Since 1980, it has been higher about two-thirds (69 pct) of the time over the first week of the new year.
Takeaway: The S&P is flat on average in the January following an especially robust year for the index and there’s a wide distribution of returns. That’s despite a +1.2 pct average January return since 1928. While the S&P is usually slightly higher during the first 5 trading days after a strong annual performance, this positive momentum fades. There were also 5 years in which the index fell by over 3 pct in January after a strong return in the prior year: 1990 (-6.9 pct), 2000 (-5.1 pct), 1981 (-4.6 pct), 2010 (-3.7 pct) and 2014 (-3.6 pct).
#2: The S&P will almost certainly deliver a third consecutive year of double-digit returns (2019: +31 pct, 2020: +18 pct, 2021 YTD: +27.6 pct), so here is the January return data after the only 9 other times this has happened over the last +90 years:
- In the January after the nine prior 3-year sequences, the S&P rallied an average of 74 basis points and was higher during the month two-thirds of the time. The worst return was -5.1 pct in January 2000 and the best was +7.0 pct in January 1946.
- During the first 5 trading days of the year, it returned an average +53 basis points and was higher two-thirds of the time.
Takeaway: after 3 years of double-digit annual returns, the S&P continues to rally during the first 5 trading days of the new year and ends slightly higher for the month of January. That said, the last two times the S&P saw a 3-peat of double-digit annual returns, it was down 5.1 pct (Jan 2000) and 3.1 pct (Jan 2015) respectively in the following January.
#3: The S&P could very well end the year up over +30 pct on a total return basis, which has only happened 8 times since 1980; here is the return data for the following Januarys:
- The S&P dropped by an average of 52 basis points during the first 5 trading days of the following year. It was down during this period half the time.
- The index fell by an average 158 basis points in January overall. It was down 63 pct of the time. The worst January return was -6.9 pct in 1990 and the best was +3.3 pct in 1996.
Takeaway: after an unusually large total annual return for the S&P (+30 pct), the index typically starts to give back some of those gains during the first month of the new year. The S&P has only rallied +30 pct in two years over the last two decades, up 32.2 pct and 31.2 pct in 2013 and 2019 respectively. The S&P fell 3.6 pct in January 2014 and lost 0.16 pct in January 2020.
Bottom line: investors shouldn’t expect this year’s positive momentum to carry through next month. Even though the S&P is flat on average in January after a particularly robust year, it has a wide distribution of returns. There’s a raft of reasons why the index suddenly turns lower in the new year, from de-risking and mid-cycle concerns to a worsening economic outlook. We are still bullish on US equities because we believe US corporate earnings will remain strong, but the bearish examples listed above are worth considering as you decide how much equity exposure you want to carry into early 2022.
#2: US used vehicle inflation is ending 2021 on a (very) high note. Here’s the last 6 months of annual inflation for this category, using the Manheim Used Vehicle Value Index (based on actual auction prices, link below):
- July 2021: +24 percent higher prices as compared to prior-year levels
- August 2021: +19 pct
- September 2021: +27 pct
- October 2021: +38 pct
- November 2021: +44 pct
- December 2021 (mid-month reading): +49 pct
This is an important trend, because rapidly rising used vehicle prices have been a key driver of overall US Consumer Price Index inflation this year. For example:
- In November, headline CPI inflation was +6.8 percent and core inflation was +4.9 percent.
- Without used vehicle inflation (+31 pct using CPI math), November headline inflation was +5.7 percent (1.1 points lower) and core was +3.6 pct (1.3 points lower).
- Put another way: used cars/trucks are just 3.4/4.3 percent of headline/core CPI, but this category was responsible for 16/27 percent of all the inflation measured by this index last month.
Takeaway: used vehicle prices have been an important marginal contributor to US inflation all year and Manheim’s most recent data says December was worse than November for this category. We should therefore expect that December’s CPI inflation print may be higher than November’s 6.8 percent reading.
#3: 78 days until the first Federal Reserve rate hike? That’s the number of days between now and March 16th, the second FOMC meeting of 2022 and the one where the Fed’s bond buying should be at an end. Fed Funds Futures increasingly believe this may also be the meeting when the committee starts to increase rates (chart courtesy of CME FedWatch, link below):
Now, 55 – 56 percent odds of a March 2022 liftoff are hardly the sign of a sure thing, but the fact that the probabilities are rising is significant:
- First, we’re getting new highs on the S&P 500 even with increasing odds of a rate hike in less than 90 days. This says equity markets are relatively comfortable with that outcome.
- Second, a March rate hike is consistent with other economic data we’ve been reviewing with you. There’s the ongoing issue of inflation (prior point about used cars/trucks), of course. But then there’s also expectations for strong Q4 GDP (Atlanta Fed GDPNow model at +7 pct) and a still tightening US labor market. A rate increase as early as March should surprise exactly nobody.
- Lastly, while markets are pulling forward their expectation of liftoff, Fed Funds are not repricing the number of rate increases in 2022. The December contract still shows 31 percent odds of 3 hikes and 22-24 percent odds of either 2 or 4 hikes next year. The symmetry there says markets see even odds of a slightly more dovish/hawkish Fed in 2022, which makes sense to us.
Takeaway: while the first rate increase of an economic cycle is rarely a stock market rally-killer, there’s no sense in being complacent on this issue. As Jessica noted above, Januarys after a strong year can see pronounced US equity volatility. There is an FOMC meeting at the end of the month (January 26), a perfect time for the Fed and Chair Powell to start conditioning markets if a March rate increase is likely. “Will they or won’t they?” could well be the market’s central question next month.
#4: US investment grade corporate bonds (using the LQD ETF as a proxy, monthly coupons not reinvested) are on track to show a 2021 total return loss of 1.4 percent while high yield corporates (HYG) are set to show a +4.4 percent gain. We’ve favored high yield the entire year, so that result is consistent with our thinking, but how did it come to pass?
The following 2021 YTD chart of US investment grade (IG) and high yield (HY) corporate bond spreads over Treasuries explains the difference. IG bond spreads have essentially gone nowhere this year (104 basis points in early January, 100 bp today). HY spreads have declined nicely (393 bp in early January, 312 bp now). Lower spreads translate into higher bond prices, everything else equal, so HY did better than IG in 2021.
Takeaway: as the chart above also highlights, current HY spreads (312 bp) are very near the lows of the year (303 bp), and those also happen to also be lows since the 2007 Financial Crisis. Therefore, we cannot rationally expect HY spreads to decline much further. While we still prefer HY over IG due to its superior yield, we do not expect to see as dramatic an outperformance from high yield corporates next year as we’ve had in 2021.
Manheim Used Vehicle Value Index: https://publish.manheim.com/en/services/consulting/used-vehicle-value-index.html