There’s an old saying on Wall Street that "trees can’t grow to the sky." Eventually, all bull markets end.
There’s another expression: "TINA," which stands for "there is no alternative," in this case meaning that investors have no other viable option but to keep buying stocks if they want to meet their long-term goals because the returns on bonds simply won’t get them to where they need to be.
The new year starts with the Morningstar U.S. Market Index having posted its best three-year returns since 1997, up a total of 78%. Bonds, meanwhile, broadly posted their first year of losses since 2013, and yields are still at historically low levels even with their latest move higher.
Now, according to Morningstar’s estimates, the stock market heads into 2022 overvalued by 5%, and many of the best-performing names are trading at especially frothy prices.
Which adage will play out in 2022? It might be a little bit of both.
More than a decade ago, Jason De Sena Trennert, chief investment strategist at Strategas Securities, helped popularize the TINA term for the stock market.
“Like it or not, TINA is still extremely relevant,” Trennert says. “With cash at zero (percent yield) and the Treasury 10-year at 1.7%, it’s very, very hard to get the returns you need” outside of equities.
That said, Trennert expects 2022 to be a year where stock market returns are also going to be harder to come by. “You’re not going to be able to get 20%-plus just for showing up in the next three years,” he says. Smart stock-picking and correct calls on performance among stock sectors will be the key to stronger performance, he believes. “It’s hard to get bearish on stocks, but I do think people should manage their expectations.”
The past year was one where the underlying fundamentals for the stock market were strong. The economy and corporate profits boomed as we emerged from the worst of the pandemic shutdown and the world’s major central banks kept a foot on the accelerator to ensure the recovery sped along.
As David Sekera, Morningstar’s chief U.S. market strategist says, 2022 looks to be a different landscape for stocks than 2021. Economic growth is expected to continue but a more moderate pace. Inflation--though expected to ease by midyear--is bubbling, and the Federal Reserve is gearing up to tap the brakes on the expansion by raising rates in order to ensure inflation doesn’t get out of control. And as shown by Wednesday's sharp sell-off on news suggesting the Fed could raise rates as soon as March, Fed policy surprises could make for bumpy going.
Complicating matters for stock investors is that much of the market is seen as expensive relative to earnings and other fundamental measures.
Morningstar measures stock prices against companies’ estimated fair values as a basis for deciding whether stocks--and the broader market--are cheap, fairly valued, or expensive. On this basis, only one corner of the market--small-value stocks--looks cheap. The rest of the market is either fairly valued or, in the case of the large, fast-growing companies that have dominated returns in recent years, meaningfully overpriced.
When it comes to valuations, Kristina Hooper, chief global market strategist at Invesco, says this is where TINA comes into play. “I liken it to when people go on a search to buy a home. They have a finite amount of time to find a house and they can’t just buy any house they like,” she says. “What we are talking about in investing is there is a finite set of options--certainly broad--but not unlimited.”
The issue for investors then becomes one of relative value. “What we find relatively attractive is stocks, although our expectation is that stock market returns are going to moderate in the coming year and we’ll see more of a convergence of returns with bonds,” she says.
Bill Nygren, chief investment officer for U.S. equities at Oakmark Funds and manager of Oakmark Select OAKLX (which earns a Morningstar Analyst Rating of Silver), points to the dividend yield on stocks versus bonds as one comparison point that shows the relative attractiveness of stocks, even with the market broadly at elevated valuation levels. The dividend yield on the Morningstar U.S. Market Index stood at 1.2% as of year-end, while the U.S. Treasury 10-year note is yielding 1.66%.
Investors get almost as much yield from the stock market as they do from bonds, Nygren says, “and while bonds aren’t going to grow in the next decade, dividends and earnings will,” Nygren says. “For the long-term investor, stocks look more attractive than bonds do.”
That doesn’t mean the stock market will be a free ride for investors. Trennert says that from his vantage point, the wild card is the Fed: “What’s changed for the market in 2022 is that the Fed is going to switch from easing to tightening.”
While historically, the start of a Fed tightening cycle hasn’t derailed a bull market, “the amount of stimulus that has been put into the system in such a short period [during the pandemic] is unlike anything anyone has ever seen. There’s been nothing like this before, and it’s hard to think that the dismount won’t be difficult.”
A particular risk for the market, Trennert says, is that inflation proves more intransigent: “The thing that is different here is in the change in the pace of inflation, which has gone to 7% from 1.5%-2% in a matter of two years, which doesn’t happen that often.”
The question, then, is for an investor that is more actively managing their portfolio, what sort of tilts make the most sense given the expected economic and policy backdrop?
Trennert says his firm is continuing with calls to favor energy, basic materials, and financials. “One of the points that we’ve made is that the [sustainable investing] movement is making energy stocks better investments,” Trennert says. Morningstar’s fair value estimates peg energy stocks broadly as the most undervalued sector in the market.
Oakmark’s Nygren also says there is value to be found in energy names and financials. While overall valuations are high, “the market today is much more bimodal,” he says. “You’ve got rapid-growers selling at triple-digit multiples [compared to earnings] and you have unloved companies--financials and energy as two strong examples--teetering on single-digit multiples.”
When it comes to financials, “even though it’s been 13 years since the financial crisis, people have sworn off investing in the banks,” Nygren says. “But today real estate is more fairly valued, loan standards are more like old-fashioned banking rather than the Wild West of 2008, and balance sheets have a lot more equity.”
Among Oakmark’s top holdings is ConocoPhillips COP, which Nygren notes has embarked on a strategy to deliver a higher level of cash flow back to shareholders, and Ally Financial ALLY, which he says is trading at less than 7 times expected earnings and is expected to buy back almost 10% of its stock per year without increasing its debt load.
Invesco’s Hooper is biased toward a portfolio that will outperform as the economy slows. Early in the year, more economically sensitive sectors may outperform, but as 2022 goes on and growth moderates, large-company stocks and the technology, consumer staples, and healthcare sectors should benefit.
“We think we are entering the slowdown portion of the economic cycle, and historically that’s where we see a moderation in returns and typically large caps and defensives turn out better performance.”