We thought we would start this week with a taste as to our views on 2022.
While you can probably find a chart that tells whatever story you want to tell (come to a conclusion and then find data to support it is the oldest trick in the industry), I like to pride myself on going where the data tells me. No one’s perfect, so I suppose I have fallen victim to the above curse, but I will often catch a nugget from a research report I am reading and then use that nugget to test out other things. With that in mind, Morgan Stanley (MS) published its 2022 look-ahead over the weekend. While I find the strategists at MS quite good, I was more interested in their forecast for U.S. employment. Basically, MS sees the U.S. unemployment rate dipping down to ~3.6% by YE2022, which would be a 1% decline from current levels:
Now, it is worth noting that MS does not have an upbeat view of U.S. stocks. They are actually underweight for 2022 and favor Europe and Japan, which they view as less impacted by inflation and with more attractive valuations. Now, I am not going to dispute that because they are smarter than I am. Rather, I am interested in the nugget that they see U.S. unemployment declining by 1% from current levels, which struck me when I read it as something that probably doesn’t happen all that often. With that in mind, I endeavored to look back as far as the Unemployment rate data goes (1948) to see how unusual declines of that magnitude were:
There have been 874 rolling 12-month periods since 1948 and of these, 112 have seen a decline in the unemployment rate of at least 1%, or a little less than 13%. So unusual, but by no means unprecedented. Okay, with that in mind, let’s see how the S&P 500 has performed when we use changes in unemployment as the factor.
Now, one note of caution, we are looking at historical changes in the unemployment rate and historical changes in the market. We did not know ahead of time that the UR was going to decline or increase and the performance of the market could have been positively or negatively impacted by the upside/downside surprise in UR. In the case of the present situation, it would be a surprise if the UR did not decline over the next year; although, I am not sure a decline of less than 1% would be bad news (more on that in a bit). So, while the historical information is interesting, it is not necessarily dispositive:
Okay, this is pretty clear – the unemployment rate declines – good; the unemployment rate increases – not as good. Not surprisingly, sharp declines in the UR coincide with very strong stock performance as these sharp declines are generally associated with emerging from recession. That said – any decline whether it’s slight (between 0% and 0.5%) or great (> 2%) coincides with strong markets on average. One thing I always find useful to look at is the hit rate – that is, what % of outcomes are positive for a given interval. With that in mind, let’s take a look:
So, again, the data is pretty supportive. If we add it up, when the unemployment rate is declining, 83% of 12-month S&P 500 performances have been positive, whereas when the UR is increasing, that % drops to 57%. Taking it a step further, let’s look at the % of outcomes that I would categorize as “stellar years” in which the market gives us 10% or more over a 12-month period:
Once again, it’s pretty compelling, with a 55% chance of a >10% return when the UR has been declining vs. a 42% chance when it has been increasing. Thought of another way, a 10% increase has been almost as likely when the UR is dropping (55%) as any increase at all has been when the UR has been rising (57%). Okay, let’s take this home with one last thing where we look at calendar year returns since 1950 vs. changes in the UR:
We have highlighted the 23 calendar years that saw declines in the UR of at least 0.5%. Of these, 19 were positive with an average calendar year return of ~11.2%. One note of caution would be that the worst year of the bunch – 1977, which saw the UR drop 1.4%, but the stock market fall 13% - also coincided with runaway inflation. While I am not in the high inflation is here to stay camp, I do think the historic parallel is at least mildly interesting.
Bottom Line: Look, I get there are a lot of ways to look at 2022 and I am sure a lot of ink is going to be spilled on this topic. But sometimes simple is best and I look the intuitive basics of this one – the unemployment rate declines, businesses have more access to labor (a key problem in 2021), consumer confidence and animal spirits rise, inflation comes down as the supply chain issues resolve themselves and this all translates into a good year. There will be some headwinds to be sure – likely rate hikes from central banks, the rolling off of stimulus, continued COVID overhang, contentious U.S. midterm elections to name a few – but walls of worry are commonplace (see the last decade), so I don’t see it as necessarily derailing what continues to look like a positive set up.
The news is mostly negative; although, there are some under-reported silver linings. The global case count is once again on the rise with daily cases now averaging more than 500k:
Now, this masks a couple of things: 1) the primary hotspot remains Europe with the rest of the world still collectively seeing case counts come down; 2) Israel, which has aggressively rolled out vaccines and boosters and therefore might serve as a template for the rest of the world, continues to report positive news.
Let’s start with a new chart, which highlights the impact of Europe on the data:
As you can see, case counts outside of Europe remain in a downtrend with the potential to take out the lows of 2021 in the coming weeks. Pivoting to Israel, both the case count and the fatality rate have been in retreat for weeks as the aggressive booster campaign in Israel has arrested the Delta surge that took hold in mid-July:
Daily fatalities in Israel have been below 10 for the entire month of November with three separate days of no fatalities. In other words, there is a pathway to emerging from the Delta surge.