Valuations are stretched with the S&P 500 trading at 21-times forward earnings, though the lack of attractive alternatives provides justification, according to Mark Hackett, chief of investment research for Nationwide’s Investment Management Group, and Ben Ayers, senior economist with Nationwide Economics.
The worry of market valuations affecting portfolios is echoed across the industry. 45.8% of advisors surveyed said market valuations is their biggest concern for the next year, trailed by inflation at 35.4%, according to “ETFs 2022.” Date: Jan. 5, 2022. Sample size: 2,039 respondents, 8.4% RIAs.
Nationwide Economics states valuation is historically high, and Fed tightening with slower expected profit increases could be a headwind for equities in 2022.
According to Hackett and Ayers, there is potential for the stock market to normalize over the next several years, with shifts in leadership and lower returns relative to more recent performance.
Moderating Expectations
Double-digit returns for balanced portfolios, which have been common over the last ten years, are not guaranteed. Given current valuations and macro-economic challenges, investors may need to moderate their expectations for returns going forward, according to Hackett and Ayers.
Alternatives offer another opportunity for investors to capture sufficient returns facing the prospect for more modest returns for moderate or balanced portfolio allocations.
According to Hackett and Ayers, small-cap, value, and international stocks are all trading at less of a premium to their historical averages than large-cap, domestic growth stocks.
Additionally, dividend-focused equities, credit-sensitive bonds, and alternative strategies may yield greater than traditional bond allocations. According to Hackett and Ayers, 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.
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