The US economy has been on a roller coaster ride in the past two years. While the Covid-19 virus has shut down a large part of our economy and has caused high unemployment rates in many service sectors, the US government’s massive fiscal and monetary stimulus response also brought on the fastest economic recovery in nearly 40 years. According to FactSet, S&P500 2021 revenue and earnings growth rate is expected to be 16% and 45% higher over 2020 level respectively (after flat revenue and 10% earnings decline in 2019).
What we learn in this process is that the US system just works because we have the right combination of independent federal reserve, balanced political system (three branches of government with separation of powers), innovative companies (multi-cultural workforce and risk-taking culture), dynamic economy and capital markets (global capital and market access). No matter how bad a crisis is, the US economy seems always capable of adapting, bouncing back and thriving over time. As Warren Buffet once famously said, “Never bet against America.”
Currently the US economy appears slightly overheated, driven by a combination of positive wealth effect from asset price increase, very low borrowing costs, strong consumer demand for goods, low unemployment, labor and physical goods shortage. As a result, consumer price inflation rose at an annual rate of 6.8% in November, the highest since 1982! While several sectors like travel, restaurant and automobile are still suffering, many others like technology, real estate and health care are thriving. Therefore, we believe it makes economic sense for the Fed to remove its monetary stimulus and for the US government to remove its fiscal stimulus both in 2022. We see rising interest rates and inflation as positive signs of strong demand and a booming economy.
US equity market likely to perform well in 2022 as profits/margins are still rising
According to FactSet, S&P500 earnings fell only 10% in 2020 but rebounded 45% in 2021, the highest since 2008. This robust performance during the Covid-19 crisis is extremely impressive and demonstrate the quality and resiliency of the largest 500 companies in the US. Smaller service-oriented businesses such as airlines, hotels, restaurants, and hair salons likely do not have such performances in 2020-2021, but they do not carry high weighting in the S&P500 index. Our main US indices are dominated by technology and diversified multinational companies that sell to the world.
Despite rising labor, energy and logistics costs, most US multinationals can pass on those higher costs to their customers worldwide through higher prices. In most cases among the larger companies, their selling prices are rising faster than their costs resulting in improving margins and profits. Our US internet and software companies are benefiting even more as they enjoy steady prices of their cloud/software-based service offerings but the unit costs of computing, data communication and cloud storage are continuously falling. The result is record net profit margin (estimated 12.6% in 2021 and up from 9% in 2011) for S&P500 companies.
For 2022, S&P500 revenue and earnings are expected to both grow around 8-9% in 2022 based on FactSet estimates. We believe this estimate is conservative and provides upside surprise potential. If we assume S&P500 earnings multiple to compress due to rising interest rates, S&P500 should still have moderate positive return in 2022.
US stock market still offers better value than bond and cash
Under the current high inflation environment, we view stocks still offer better value than its alternatives (bond and cash). Currently, interest rates in Europe, Japan and US are still slightly negative to zero while US 10-year treasury yields around 1.8% only with a fixed coupon. After adjusting for inflation, the real yields of bonds and cash deposits are negative 3-5%/year around the world now. On the other hand, S&P 500 earning yield is around 4.5% and its earnings are expected to grow 8-9% in 2022. Therefore, for the average global investor, holding the S&P 500 index still presents a better value than holding bonds and cash today.
Indeed, for most of 2020 and 2021, we have observed that much capital has flowed from bond/cash towards stocks/real estate and other financial assets in search of higher returns. And we expect this capital flow to continue in 2022 even as the US Fed raises its short-term interest rates from 0.08% towards 1% in 2022 and towards the pre-pandemic level of 2.5%.