Q4 2021 Market Update: Herd Immunity?

sheep herd with dog in middle

We can sum up 2021 quite simply: Covid, Covid, Covid … and the S&P 500 stock market index hit a record high (more than 70 times). But let’s look “under the hood” and assess prospects for 2022.

This year might be better—at least for Covid, as there is hope for the holy grail, “herd immunity.”

Investors, who often exhibit herd-like behavior, also seem to be hoping for immunity—from inexorable market history. While Covid has been a once-in-a-century phenomenon, we also have been living through what might be the greatest bubble in the past century, featuring all the warning signs of an epic top.

2021 in Review

We entered 2021 expecting muted returns after the unprecedented length and magnitude of the bull market that last bottomed in 2009. Based on market history, the odds of large stock market gains in 2021 were about 1 in 20. Yet the S&P 500 defied the odds and returned almost 29%.

While Clean Yield portfolios ended the year with solid gains, our conservative positioning was a headwind for three reasons (we expect this to shift to a tailwind in 2022):

  • We favored international stocks because they were more attractively valued, and the companies (particularly European) are generally more progressive than those in the U.S. Despite the appealing valuations, these stocks trailed U.S. stocks.
  • To reduce portfolio risk, we shifted to more-stable sectors, such as Telecom, Consumer Staples, and Health Care. The big companies that contributed the most to the S&P 500’s performance were high-valuation technology companies (Microsoft, Google, Facebook, and Tesla).
  • We invested in not only large companies (which dominate the returns of the S&P 500) but also mid-sized and small companies. Small-company stocks generally returned “only” about 14%.

Not only were the S&P 500’s returns extraordinary, but the gap between the returns of stocks and bonds was the widest on record. As interest rates rose and bond prices fell, many fixed-income investors saw negative returns. However, our conservative approach to fixed income resulted in flat returns in most portfolios.

In classic fashion, investors “chased performance” by piling into stocks and abandoning bonds. That left both individual and professional investors with record-low holdings of bonds compared to stocks at year-end. As contrarians, we think that has created a value opportunity in bonds moving into 2022.

A Little History

There have been several market bubbles in the last century, and the current environment bears a striking resemblance to the technology stock bubble of the 1990s.

Common bubble characteristics are extremely expensive valuations, investor overconfidence, excessive leverage (debt), sharp price gains, truckloads of initial public offerings (IPOs), and rampant speculation.

The current market is following the bubble script. The end phase of a mania typically begins with sharp declines in the most-speculative stocks. Current examples are Robinhood (a popular mobile trading app), down 80% since going public in July; Rivian (electric trucks), -50% since going public in November; and Coinbase (cryptocurrency exchange), -45% from its IPO in April.

The next act in the script is when investors rotate into “safer” stocks, particularly the dominant technology companies (Apple, for example, now has a market value of about $3 TRILLION, which is equivalent to the value of all of the stocks on the London Stock Exchange).

Bear markets don’t happen instantaneously. The initial decline is usually viewed as a “healthy correction” of an overheated market, and investors buy the new “bargains.” But eventually, buying power is exhausted as investors are generally already fully in the market, and prices fall further. Psychology tips toward fear, rather than greed, and the rush for the exit begins. Selling pressure will be exacerbated this time by redemptions of index funds, as the funds hold no cash reserves to meet redemptions.

What’s Ahead in 2022?

We always start by observing the conventional wisdom over what’s ahead for the economy, interest rates, corporate earnings, and stock market returns. Then we assess the likelihood that those expectations will be correct. The typical view is that economic growth will be above the economy’s estimated long-term potential, inflation will remain historically high, the Federal Reserve will begin to tighten monetary policy and raise interest rates, and the stock market will have more-moderate—but still positive—returns.

We, however, expect the recent upward pressure on inflation and interest rates to diminish. The economy will likely be weaker than expected because of the absence of $2 trillion of stimulus by the federal government, a record trade deficit, and flagging demand by consumers, who binged on durable goods during the pandemic.

We may be on the cusp of an era of frugality. The University of Michigan Index of Consumer Expectations is at an eight-year low, showing that consumers have a pessimistic outlook for the economy, which is likely to constrain their spending. In addition, a recent survey showed that despite the bubbles in the stock market and in the housing market, the percentage of respondents over the age of 55 who expect a financially secure retirement was the lowest in four years!

Remember that inflation indexes, like most economic statistics, say what has already happened (with a lag), not what will happen. There have been many instances of high—but fleeting—inflation readings that were soon followed by much lower inflation, or even declining prices (see the early 1930s, late 1940s, early 1980s, and 2008-2009). We expect the same pattern in the coming months. Along with weakening consumer spending, high prices create the incentive to increase the production of goods. The law of supply and demand has not been repealed.


We recommend a minimum portfolio allocation to stocks, especially the largest technology companies. We continue to trim or sell stocks with outsized gains and rotate into laggards that are attractively valued, including more-stable sectors, international stocks, and stocks with high dividend yields.

We also favor bonds (the best house in an overpriced neighborhood). Inflation fears will likely recede, and bond yields will decline, leading to higher bond prices. Hold maximum cash (or more bonds if averse to cash).

Herd immunity? We’re hopeful on the Covid front, less so for financial markets.