Investors poured almost US$900 billion into equity funds in 2021. According to the Bank of America, that exceeds the combined total from the past 19 years. Last year we noted “global stocks are now a US$100 trillion asset class”. Today it is a US$120 trillion asset class, the highest in history and equal to 145% of world GDP.
Earnings expectations were compelling. In January, the market was expecting S&P500 company earnings to come in at US$168 per share. Over the course of the year, that figure jumped to US$209 per share. As a result, the S&P 500 printed a new all-time high 70 times through the year, the second-highest number ever.
Certainly, the expected earnings backdrop is less favorable for 2022. The market expects S&P500 company earnings for 2022 to come in at US$225 per share. This growth in earnings of 7.7% would be one of the lowest expected growth rates of the past three decades.
While valuations are expensive compared to history, we believe equities can still perform reasonably well in 2022 for the following three reasons:
The economic backdrop, while slower, still suggests growth at above trend levels.
US GDP versus trend
High valuations and potential tax changes make buybacks less compelling but a healthy backdrop does exist for dividends given the current low payout ratio for the S&P 500 (33% vs its long-term average of 50%), low leverage and earnings stability.
S&P500 companies leverage (net debt/EBITDA)
There are record amounts of cash sitting on the sidelines in money market funds.
Money market fund assets (US$ bn)
Companies are certainly cashed up. Cash and short-term investments on corporate balance sheets globally are at an all-time high of US$6.8 trillion. US companies have accumulated US$2.8 trillion with Apple, Amazon, Alphabet, Microsoft and Meta (former Facebook) making up a quarter of that cash pile. Balance sheets have been getting stronger as the recovery has proceeded.
Companies have paid US$522 billion in dividends this year and spent US$729 billion in buying back their own stock. Apple can’t get rid of money fast enough. Last year, it spent roughly US$81 billion buying back its stock.
Apple shares outstanding (US$ bn) and market value (US$ trn)
US$6.8trn – Cash and short-term investments on corporate balance sheets.
The torrent of inexpensive money has benefitted all types of businesses. It helped struggling businesses like cruise operators and airlines raise cash and ease the threat of bankruptcy. It helped thriving businesses lower interest expenses by refinancing older debt. And while we expect money to be more expensive in 2022, we are not expecting it to be significantly so. Particularly as we expect inflation to recede as supply rises and demand slows.
Inflation is the single biggest issue for equity investors in 2022 given the risk it could pose to profit margins. On this count, the type of inflation we have is key. Demand-pull inflation, where higher prices are driven by increased buying activity from consumers, is what we are experiencing currently.
Profit margins tend to be protected in this environment as good companies have the ability to pass on the higher costs to eager consumers. This particularly applies to the technology sector where margins are currently two-times the broader S&P500.