The Energy Select Sector SPDR ETF returned 53% in 2021 despite recent Omicron variant-related declines.
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Stock market investors had a lot to like in 2021.
Those who simply bought the SPDR S&P 500 exchange-traded fund (ticker: SPY) would have enjoyed a return of almost 30%, including dividends, though Thursday. All 11 sectors in the index returned at least 14% for the first time since 1995, and nearly nine in 10 of its components are in positive territory for the year. The Dow Jones Industrial Average returned 21.5%, including dividends.
The S&P 500 index beat the Nasdaq Composite’s return of 23% for the first time since 2016, by about six percentage points. That was the S&P 500’s best performance, relative to the Nasdaq, since 2002, but the long-term record still favors the technology-heavy index—the Nasdaq has lagged behind the S&P 500 only 12 times over the past 30 years.
Tech stocks certainly didn’t have a shabby year. The Technology Select Sector SPDR ETF (XLK), which includes stocks in the S&P 500, returned almost 36% in 2021. That’s about a point ahead of the Financial Select Sector SPDR ETF (XLF), which was among the most popular sector calls on Wall Street as the year began. Banks looked particularly attractive in late 2020, as strategists anticipated higher interest rates and a healing economy, and pointed to cheaper-than-average valuations and plenty of cash on bank balance sheets.
Those arguments still hold for banks and other financials for 2022. The Federal Reserve could begin increasing its target interest rate around the middle of next year—lifting the rates that banks can charge on loans they extend—while more of that excess capital could be returned to shareholders via higher dividends, stock buybacks, or both. The Invesco KBW Bank ETF (KBWB), which provides concentrated exposure to the group, returned about 38% in 2021.
Rounding out the S&P’s top five sectors in 2021 were consumer discretionary, which returned some 28%; real estate, which generated about 46%; and the best performer—energy: The Energy Select Sector SPDR ETF (XLE) returned some 53% in 2021 despite recent Omicron variant-related declines. The coming year could be another good one for the group, as the global economic recovery continues and demand for oil and gas rises. The sector will remain sensitive to pandemic headlines, but if the Delta and Omicron waves couldn’t stop its rally for long, there’s little for long-term-focused investors to fear next year, either.
With economists generally forecasting less feverish, but still hot, inflation in the U.S. in 2022, energy companies should be able to provide a hedge. When the value of the U.S. dollar declines, a barrel of oil priced in the currency is worth more dollars. That’s good for companies selling the commodity. A greater focus among American producers on returning cash to shareholders, instead of single-mindedly pursuing production volume growth—what the industry calls the “Shale 3.0” movement—should be good for energy stocks.
“Energy is the poster child for inflation-protected yield,” writes Savita Subramanian, BofA Securities’ head of U.S. equity and quantitative strategy, in her year-ahead outlook report. “It has the highest free cash flow yield (which is also a good factor amid Fed rate-hiking cycles) and the highest inflation beta of all sectors.”
The combined market value of the 21 energy stocks in the S&P 500 is roughly $1 trillion. That makes the entire sector’s value barely more than the 2021 increase in Apple ’s (AAPL) market cap, to just a hair below $3 trillion. The iPhone maker’s shareholders enjoyed a return of 35% in the year, versus nearly 67% for Google parent Alphabet (GOOGL) and 54% for Microsoft (MSFT). Facebook parent Meta Platforms (FB) added 26%, while Amazon.com (AMZN) basically traded sideways for much of 2021, edging up 4%, after surging 76% in 2020. The five Big Tech companies together are worth more than $10 trillion. Add Tesla (TSLA), whose stock jumped 52% in 2021, and you get well over $11 trillion in combined market value.
For the Big Techs, the tug of war between fast-growing earnings and macro pressure on stock multiples will determine returns in 2022. Alphabet and Meta Platforms are the cheapest, going for 26 times and 24 times 2022 forecast earnings, respectively, but they’re also expected to boost profits at a slower pace than their peers. Amazon trades for 66 times 2022 consensus earnings per share, which are expected to be up 25% from this year’s.
On the opposite end of the market-cap spectrum, the iShares Russell 2000 ETF (IWM), which mirrors the small-cap Russell 2000, returned about 15% in 2021. That compares with 27% for the S&P 600 -tracking iShares Core S&P Small-Cap ETF (IJR). The latter index is tougher to get into: Companies must have been profitable for a year or more and meet minimum liquidity and public float criteria.
Those factors were clearly in vogue in 2021 and should remain so in 2022. “Small- caps appear very attractive from a valuation basis,” writes Keith Lerner, co-chief investment officer at Truist Advisory Services, in his outlook. “Fundamentals are also strong, with earnings at a cycle high relative to large-caps. Given we expect strong economic growth over the next year, our work suggests small-caps are poised to outperform.”
Watch your back, S&P 500.
Write to Nicholas Jasinski at firstname.lastname@example.org