Market Outlook: 2022 And Beyond!

Market Review

The table below shows 10 exchange traded funds (ETFs) that represent good proxies for 5 broad market stock indices and 5 broad market bond indices. They are listed in order from the highest expected risk to the lowest expected risk. Emerging markets (SPEM) posted a small gain of +1.73% for calendar year 2021. Developed markets (SPDW) fared much better last year with a solid gain of +10.69%. Domestic stocks were the stars of the show - with stunning results of +26.95%, +24.85%, and +29.85% for US small, mid, and large caps. The bond side of the table was a mixed bag as the FOMC started to wind down their asset purchase program and the predicted number of rate hikes for 2022 rose from 2 to at least 4. The high yield bond space (SPHY) performed roughly as expected with a solid +5.67% return. Corporate bonds (SPBO) were the start of the red ink - logging a -1.17% performance. Long, intermediate, and short Treasury indices posted annual returns of -4.98%, -2.51%, and -0.62% respectively.

Close	2021-12-31
Ticker	Name	012 Mo	024 Mo	036 Mo	060 Mo	120 Mo
SPEM	SPDR Portfolio Emerging Markets ETF	1.73%	8.13%	11.77%	10.17%	5.93%
SPDW	SPDR Portfolio Developed World ex-US ETF	10.69%	10.95%	14.46%	10.17%	8.26%
SPSM	SPDR Portfolio S&P 600 Small Cap ETF	26.95%	19.10%	21.22%	12.74%	9.90%
SPMD	SPDR Portfolio S&P 400 Mid Cap ETF	24.85%	19.01%	20.97%	12.87%	7.65%
SPLG	SPDR Portfolio S&P 500 ETF	29.85%	23.86%	26.42%	18.41%	16.52%
SPHY	SPDR Portfolio High Yield Bond ETF	5.67%	6.27%	8.43%	5.81%	4.99%
SPBO	SPDR Portfolio Corporate Bond ETF	-1.17%	4.24%	7.70%	5.32%	4.30%
SPTL	SPDR Portfolio Long Term Treasury ETF	-4.98%	5.23%	8.40%	6.48%	4.37%
SPTI	SPDR Portfolio Intermediate Term Treasury ETF	-2.51%	2.37%	3.63%	2.87%	1.89%
SPTS	SPDR Portfolio Short Term Treasury ETF	-0.62%	1.27%	2.02%	1.56%	1.11%
BIL	SPDR Bloomberg 1-3 Month T-Bill ETF	-0.09%	0.15%	0.77%	0.94%	0.45%
Note:	All returns greater than 12 months are annualized.

Return Correlations

One of the most popular questions is always "how is the market doing?" From the table shown above, we track at least 10 different market indices to get a sense of what happened with the stretch goal of deciphering what may happen in the future. Over the trailing 36 months, many of these stock indices have shown a tendency to move in the same direction each month. This is highlighted by the red areas in this correlation chart. The correlation between US mid cap stocks (SPMD) and international developed stocks (SPDW) of 0.93 indicates that theses two asset classes tended to move in the same direction about 93% of the time over the past three years. There has been little diversification benefit to adding SPDW into a portfolio of domestic stocks.

	SPEM	SPDW	SPSM	SPMD	SPLG	SPHY	SPBO	SPTL	SPTI	SPTS	BIL
SPEM	1.00	0.86	0.89	0.85	0.79	0.84	0.53	-0.44	-0.51	-0.50	-0.25
SPDW	0.86	1.00	0.92	0.93	0.91	0.79	0.49	-0.43	-0.49	-0.51	-0.22
SPSM	0.89	0.92	1.00	0.97	0.88	0.83	0.46	-0.52	-0.62	-0.61	-0.22
SPMD	0.85	0.93	0.97	1.00	0.94	0.84	0.48	-0.49	-0.59	-0.61	-0.24
SPLG	0.79	0.91	0.88	0.94	1.00	0.79	0.53	-0.34	-0.46	-0.54	-0.22
SPHY	0.84	0.79	0.83	0.84	0.79	1.00	0.75	-0.26	-0.41	-0.52	-0.29
SPBO	0.53	0.49	0.46	0.48	0.53	0.75	1.00	0.40	0.22	-0.01	-0.08
SPTL	-0.44	-0.43	-0.52	-0.49	-0.34	-0.26	0.40	1.00	0.89	0.68	0.31
SPTI	-0.51	-0.49	-0.62	-0.59	-0.46	-0.41	0.22	0.89	1.00	0.89	0.40
SPTS	-0.50	-0.51	-0.61	-0.61	-0.54	-0.52	-0.01	0.68	0.89	1.00	0.52
BIL	-0.25	-0.22	-0.22	-0.24	-0.22	-0.29	-0.08	0.31	0.40	0.52	1.00

The green portions of this chart, however, do show a diversification benefit over the past three years in holding a combination of stocks and bonds. The largest monthly negative correlation over this time period came when combining US small cap stocks (SPSM) with intermediate term US Treasuries (SPTI). These two asset classes tended to move in the opposite direction about 61% of the time over the past 36 months. The effect of this negative correlation is to "smooth" out what might otherwise be a very bumpy ride for our portfolios over time.

Market Outlook

We use a fundamental approach to managing return expectations and using these expectations as inputs to our portfolio optimization process. This results in a long term outlook that “automatically” adjusts for temporary valuation changes. Over the next full market cycle (10+ years), we expect developed international stocks to offer the highest expected returns followed by US small cap and emerging markets stocks. Expected returns for bonds are significantly lower than stocks for all measures of credit and maturity risk. It should be noted that our expected returns for US large cap stocks over the next market cycle are all well below the long term averages over the past 10 years and since 1926.

Resources

https://finance.yahoo.com/

https://www.ssga.com/us/en/intermediary/etfs

https://www.investopedia.com/terms/c/correlation.asp#:~:text=Correlation%2C%20in%20the%20finance%20and,between%20%2D1.0%20and%20%2B1.0.

Disclaimer

Past performance is no guarantee of future results. Any investment involves some amount of risk and may not be suitable for all — or any — individuals. You should consult with your investment advisor before acting on this — or any — financial information.