Last year brought remarkable outperformance from equities, capping a decade of strong growth, particularly from the technology sector. This trend has been around since the ending of the global financial crisis in 2009, with the mega-cap tech stocks growing an astounding 1,000% cumulatively in the last ten years, compared to the S&P 500 Index, which grew 329% over the same time, Mark Hackett, chief of investment research for Nationwide’s Investment Management Group, writes in a blog post.
Valuations are extremely high for the tech sector, a record 27 times the forward earnings for 2021 compared to 19 times the forward earnings for the long-term average. Market analysts are increasingly concerned about the ability to sustain such growth, and many believe that equity leadership should expand into other sectors and away from the “over-dependence on tech stocks for returns,” writes Hackett.
Last year had earnings growth of 40–50%, and some believe that the increase in earnings justifies why stocks have such high valuations now, but it’s potentially shaky ground to be standing on, believes Hackett.
The increase in earnings equating to high valuations is “a reasonable assumption, but S&P 500’s current multiple of 21-times forward earnings is rare territory, eclipsed in recent history only by the dot-com bubble of the late 1990s and the pre-COVID months of 2020,” Hackett writes
Furthermore, stock performance has vastly outpaced earnings growth in the last three years in particular, with the S&P 500 averaging 22% annualized returns but earnings only growing an average of 8% annually.
“If valuations seem more likely to contract than expand, we will be increasingly reliant on estimate revisions to produce return opportunities, and those showed signs of slowing in Q4 of 2021. It’s too early to say if the stall will be temporary or persistent,” explains Hackett.
Within the traditional bond space, bond investors should expect flat-to-negative returns over the next few years as rates are gradually pushed higher and credit spreads remain near record lows. The days of double-digit returns for a balanced portfolio could very well have come to an end, taking into account current valuations as well as challenges to the economy, such as inflation, the pandemic, supply chain issues, and beyond.
Where to Find Returns in a Changing Market Environment
Many advisors are moving away from a traditional portfolio and are exploring alternatives to seek income and better returns in a more uncertain and challenging market environment. Some areas of opportunity that Hackett highlights are small-cap, value, and international stocks that are currently trading at less of a premium than the hugely popular large-cap stocks, particularly those oriented to growth.
Within the bond space, alternative strategies, dividend-focused equities, and credit-sensitive bonds have the potential for better yields than the more traditional bonds given current market pressures and economic predictions, explains Hackett.
“Active management may also hold advantages in this environment, especially if the mega-cap tech names hand off leadership to a broader group of stocks,” writes Hackett.
Nationwide offers a variety of actively managed ETFs for advisors that cater to a range of investment exposures and strategies.
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