ESG Advisors │2021 Review and 2022 Market Commentary

We would like to take the time to discuss this past year's market conditions with you and elaborate on what we see ahead for 2022.

It certainly has been an interesting year for the markets—considering all of the unique factors caused by the pandemic.

Last year, the market anticipated a reopening of the economy and a return to normalcy on some level for most. However, while some parts of the economy stabilized, many industries and macro factors remain impacted due to the influences of government policies.

This is such a unique time in history that while we can typically look to past performance in the markets for some indication of future trends, the "playbooks" were not applicable to create a reliable market narrative for this past year.

For example, considering the multiple stimulus checks that the governments had to introduce to the economic system to stabilize the job market, risk assets were sure to rise. Interest rates were below zero, unemployment continued to decline, and home prices rose sharply as well as equity prices. With that, commodity prices in food, energy, and metals also rose by a wide margin. Lastly, inflation became a harsh reality for the first time since the 1970s. The backdrop of inflation and an eventual reduction of the massive accommodative fiscal and monetary policy will be a headwind for the upcoming year.

Let's take a look at standout market sectors in 2021. We saw sectors such as large-cap technology, semiconductors, financials, and energy leading the market. On the other hand, many of the "stay-at-home" stocks such as Peloton, Docusign, Teledoc, and Zoom saw a large decline compared to the year before.

At some point, valuations do matter, and many of the recent IPO's that came to market in 2021 were also punished because the valuations were so inflated. It's also important to note that many income products were flat to down on the year as the market anticipated an increase in rates as the 10-year note yielded 1% at the beginning of the year and 1.7% by the end of the year.

ESG Asset Management has always preferred a more significant concentration in long-term secular growth sectors with valuations higher than the market but reasonable relative to their growth prospects.

The economy is strong, and the consumer is flush, but the market is not cheap relative to historic levels, and we believe the fed needs to pull in the reigns and employ a tighter monetary policy.

Our response to this particular setup for our investments has raised cash to at least 10% and as high as 20% for some with lower risk profiles. Our team has kept our fixed income (bond) exposure to 15 to 20% because yields will go higher in the short term, and we could easily see the ten-year treasury yield at 2.25% - 2.50% sometime in 2022. This will be an area to watch for potential opportunities to increase our exposure to bonds.
We don't believe the overall market can handle much higher interest rates because of the massive debt we have added to our national debt. Moreover, the impact of easy money on asset prices can not be overstated.

Lastly, we have reduced expensive, over-valued positions even if we liked the long-term growth prospects because they simply will not work in this environment. In addition, we have trimmed almost any company with a vulnerable balance sheet (high debt relative to its market capitalization). This is essentially a move towards higher quality stocks with sound fundamental financials that can do well in a rising rate environment.

ESG continues to like secular growth, but we have trimmed positions that have worked well over the last five years. Our view is that commodities and certain "value" sectors will outperform such as banks, basic materials, and energy companies. We will continue to add to that theme over the first quarter.

We will maintain our large positions in large-cap technology positions such as Google, Microsoft, Apple, Amazon, and Facebook because they are considered safety names due to their incredible balance sheets and "fortress-like moats" to their business models. These names will certainly participate in any significant market corrections, but they will also hold up much better to other unforeseen exogenous events that could create market volatility. As a result, we believe they have a strong possibility to capture performance on the upside with less downside capture than the overall market.

At the beginning of the year, the overall market was trading at over 22 times its price to earnings multiple. This is historically high, but this valuation level was warranted and expected when the cost to borrow is cheap in a very low-interest-rate environment. If short-term rates rise considerably, we could see market multiples compress to under 18.

The earnings for 2022 are projected to be $230/share, which equates to 4600 for the S&P 500 index value as more reasonable, but if earnings come in lower due to wage inflation and other input costs rising, that could be lower. That is why we are projecting downside risks down to the 3910 - 4140 level (17 – 18 x earnings), presenting a solid buying opportunity. This equates to a 10 - 15%+ market correction from our current levels. Outside of the initial equity market selloff in March of 2020 due to the first wave of Covid shutdowns, we have not seen a significant pullback in the market for several years. Typically, we see annual pullbacks in the market of 10% or more.

It is essential to know the risks as they have increased over the few months based upon the Federal Reserve's intention of reducing the balance sheet sooner than expected. When the fed reduces its balance sheet by slowing the pace at which it buys back bonds, it reduces the amount of money flowing through the economy. Which, in theory, slows down expansion/growth to prevent the economy from overheating. This is what we call a tighter monetary policy during periods of economic expansion to combat high inflation.

On a positive note, equities are an excellent hedge against inflation, and we own companies that are best of breed and growing with great cash flows. We will use corrections to add to our positions and buy new companies that we like when they go on sale. As active managers, we do not sit and watch to let the market do the heavy lifting. Instead, we strategically capitalize on opportunities that can provide alpha to our overall portfolio above the market's behavior.

As you know, we adjust our market risk to all your portfolios as we see fit and have your best interests in mind.

Please email me with any questions, and we look forward to catching up with everyone. We are grateful for the opportunity to continue working with you in 2022.