Having seen the equity markets over the past 25 years closely, one important inference is that, irrespective of the level of volatility and related market performance, they always present an opportunity for investors with a long term, buy-and-hold strategy. Short term investing has always been a lot riskier and is definitely not for the faint-hearted.
The past decade has been quite a roller coaster ride for stocks. From 2012 to 2021, the average return from S&P 500 was 14.70% annually. In general, when people say “the stock market,” they mean the S&P 500 index. While there are thousands of stocks trading on U.S. stock exchanges, the S&P 500 comprises about 80% of the entire stock market value, making it a useful proxy for the performance of the stock market as a whole.
Over the past 10 years, the S&P 500 was up between 12% to 19% in almost 4 years and more than 20% in 4 years while leaving the remainder 2 years with negative or near zero performance. To put it another way, six of those 10 years resulted in outcomes that were very different from the 14.8% annualized average return over the decade. Of those six different years, two generated significantly lower returns (with the year 2018 resulting in losses) while four years delivered substantially higher returns.
Two of those years — 2013 and 2019 — generated more than 30% returns, helping to make up for the years that saw below-average returns.
The trend continues wherein, in 2022, we see stock markets in the United States accounting for nearly 60% of world stocks, with a major contribution from the New York Stock Exchange (NYSE) with an equity market capitalization of just over 27.2 trillion U.S. dollars as of March 2022.
The financial crisis of the late 2000s cast a decade-long shadow over the global economy. An extended period of household and public sector deleveraging leaned against growth, which was already under pressure from weakening demographics. Meanwhile, large-scale spare capacity helped keep inflation persistently low, and even highly accommodative monetary policies failed to generate much lift. With all this going on, the economic cycle still survived for over 10 years and could have lasted longer had the coronavirus pandemic not struck. While the long-term implications of the latest shock from the pandemic are yet to unfold, the Ukraine Russia conflict in 2022 shall further add to the implications. Some changes seem very apparent and the most important one in this is a somewhat different Inflationary dynamic. In recent times, economies have closed output gaps much more quickly, with fiscal and monetary policies now working in partnership. I expect an increase in long-term inflation projections with a lower risk of persistent inflationary pressure, leading to less clarity on growth.
With the above context, the Global GDP growth is expected to be around 2.20% over the next 10 years — which is relatively lower than the 2.90% seen from 2010 to 2020 and 2.7% from 2000 to 2020.
The US economy expanded by 5.7% in 2021 — the strongest growth rate since 1984, and in comparison to a record 3.4% contraction in 2020. The US had witnessed its fair share of stable inflation over the last decade. It’s the pandemic that brought about a change in the dynamics, with the US now facing increased inflation. The Personal Consumption Expenditure inflation is at 4.3% and Current CPI Inflation is at 8.3% in April 2022, led by increased energy prices. However, aggressive fiscal policy and easy monetary policy in an economy with stronger wage growth and inflation expectations will enable the Federal Reserve to meet its long-run goal of 2% consumption deflator inflation while modestly exceeding this target in the short run. A near-zero interest rate regime and high amounts of liquidity through QE drove the stock markets to new highs. While that lasted longer than expected, the Fed has ended its bond purchasing program and is on to an aggressive interest rate hike drive in a bid to control inflation at a much faster pace than in the 1990s and early 2000s. In short, in the coming year, fixed income shall be subject to a stronger than usual influence from the central bank’s inflation-targeting credibility.
Inflation in the EU zone hit a new record of 8.1% in May 2022 amid soaring food prices fueled in part by Russia’s war in Ukraine. Inflation for the EU is expected to reach 6.8% this year as Russia’s war on Ukraine — and the breakdown of economic relations between Moscow and most of Europe — continues to hit economies.
BoE and ECB continue to buy investment-grade debt — which should further lead to anchor spread in the Euro area, albeit at tight levels on persistently high inflation expectations, thereby compelling a rate increase.
China and India’s growth have been the drivers for the emerging economies. China, expected to see a further decline in GDP to 4.2% and India at 6.0% still continue to attract investors.
Despite short-term uncertainty, the strategic investment case for Chinese public and private markets remains strong as the rewards outweigh the risks over the long term. Diversification opportunities, currency appreciation, and potential alpha opportunities may offset Chinese assets’ relatively higher volatility for U.S.-dollar based investors. Markets continue to wait for China’s reforms: Expanding the middle class and transitioning from an export-driven toward a more consumption and innovation-driven economy, to provide improved access to foreign investors and change the investor mix. China represents almost a fifth of the world GDP and has huge asset markets, but the non-Chinese investment is still a small share — which gives investors an opportunity for strategic allocations in their portfolios.
Overall, the Equity markets in the past decade have been driven by fast-moving technologies such as AI, Robotics, Finance, Fintech Healthcare & Pharma, Consumer Discretionary, Renewable Energy and Commodities (particularly metals) as investors chased growth stocks, with value stocks lagging. Mega Caps were leading the way by hitting all times market highs. The creation of wealth was majorly in the fast-paced technology and Fintech space. Monetary policies were loose, and some sort of tightening started later in the past decade (until the global pandemic).
In summary, the market has a really hard time setting a direction; whenever a direction is set it’s short-lived. Rising commodities reflect rising inflation. However, a rising USD is deflationary.
Monetary tightening because of rising commodity prices results in strongly opposing dynamics. This creates uncertainty in the market, with investors unable to make a decision. Emotional investors press the ‘sell button’, accumulate cash (which amplifies the bull-run in the US Dollar as capital flows out of risk assets into ‘fiat money’) and partially hold cash/buy commodities. However, this is not a sustainable market situation.
We are witnessing the above trend right now. Hoping strongly that the effect of monetary interventions start kicking in and start clearing out irrational decisions by clueless investors.