Equity Returns Keep Going and Going and…
The ascent of U.S. equity returns, like the Energizer bunny, remained undeterred during 2021, exceeding 20.0% for the third consecutive year. The Russell 3000 Index, a broad measure of the investable U.S. equity market, surged 9.3% during the final quarter of 2021 to close the year up 25.7%, which materially exceeded their median return of 3.8% and 14.2%, respectively, over the last 30 years. U.S. Large Cap increased 26.5% while U.S. Small Cap rose 14.8%. Additionally, U.S. equities continued their leadership capturing positive relative performance over their foreign peers.
Foreign markets, while positive, were more restrained. The MSCI All-Country World ex USA Index rose during the quarter and year over year by 2.8% and 13.5%, respectively. For the year, developed markets rose 11.3% while emerging markets declined 2.5%.
Attention has been given to “factors,” those specific drivers of investment return. Style orientation was a key driver during 2021 as U.S. Large Cap Growth advanced during the fourth quarter to continue its relative outperformance over Value at 27.6% versus 25.2%. The opposite was exhibited in U.S. Small Cap as Value materially outperformed Growth at 28.3% versus 2.8%. According to MSCI, factors other than style orientation captured impressive performance. Quality increased 27.6% while High Dividend Yield rose 21.9% and Minimum Volatility grew 21.0%. These same factors performed outside the United States at 14.5%, 9.4% and 9.1%, respectively.
Seeing the Trees through the Forest
When considering investing in equities, many factors, themes, opinions, or other information arise that may crowd-out critical analysis and thought. Through our process, we seek the opportunity, or the “trees,” versus the groupthink of the “forest.”
One aspect is the revenue and earnings power of companies. Currently, analysts surveyed by FactSet appear optimistic regarding growth of both revenue and earnings for 2022. For U.S. equities, current estimates by analysts project revenues and earnings to grow 7.8% and 10.4%, respectively. While this is slower than the growth anticipated for all of 2021 (pending fourth quarter reports), upward revisions by analysts continue to outpace downward revisions. Outside the United States, estimates for both revenues and earnings are also positive at 4.9% and 5.8%, respectively.
Valuation is another criterion. Currently, the trailing 12-month Price-to-Earnings ratio (P/E) for domestic equities is 26.1x, materially above its historical average of 19.9x. Likewise, its P/E for the next 12 months of 22.3x surpasses its historical average of 15.9x. For foreign equities, valuation may appear more reasonable as the trailing 12-month P/E stands near its historical average at 16.4x versus 16.2x. Its forward, or next 12-month, P/E of 14.3x modestly exceeds its historical average of 13.1x.
A few observations are warranted. First, investors have consistently bid up domestic versus foreign equities, primarily given the perceived relative earnings power of U.S. corporations versus their foreign peers. Secondly, foreign equities, as measured by broad benchmarks, have historically traded at a discount to their U.S. peers.
Previously, we acknowledged two factors that drove performance during 2021. The highest performing factor was Quality. We define quality companies as those with resilient business models whose valuation appears to present opportunity relative to peers and the overall investable market. Growth was another factor which performed well.
We define growth companies as those which appear able to sustain and grow both revenue and earnings relative to peers and the overall market.
These, coupled with valuation and other aspects of our process, have captured meaningful returns for our clients.
A Continuation of Our Cautious Optimism
While equity valuations may appear stretched, we remain guardedly optimistic as we traverse 2022. Markets are forward-looking, fluid and uncertain. Our proprietary process emphasizes risk management and is dynamic, such that we stand ready to act on any near-term catalysts that may offer opportunity to reduce risk or enhance return. Currently, we are retaining our neutral asset allocation positioning regarding our equity exposures within both domestic and foreign equities.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.