It Only Gets Harder from Here: Valuations, Bond Environment and Wage Growth

It Only Gets Harder from Here: Valuations, Bond Environment and Wage Growth

If we look back at the stock and bond markets with a Monday Morning quarterback lens post-2008 financial crisis, one has to consider if the “easy money” has already been made. It’s almost hard to believe that the historically good run in equity markets has also been coupled with a favorable bond environment as well, with returns looking very solid net of inflation through many portfolios. The simplicity of this gain also bears noting  – if you simply bought the S&P 500 and coupled it with an aggregate bond strategy solely based in the United States, you did very well for yourself.

Note: SPY used for S&P 500 index proxy, AGG for aggregate bonds, DBC for commodities, EFA for international developed companies, and VWO for emerging markets. 

Naturally, we can ascertain from this chart that it hasn’t been a totally smooth ride from the equities perspective, but it is also safe to say that stocks have pretty much acted as stocks should. It also should be noted that a globally diversified portfolio detracted from your gains over this period compared to a solely U.S.-focused one. 

Looking forward, as we digest both the longer-term past as well as the last 12 months, some headwinds are developing that may affect the future of our portfolio management. Some of these will be more fleshed out in the remainder of our commentary, as they bear a deeper dive. 

Here are three of the main challenges we see as we go forward.

Stretched Valuations, Particularly in U.S. Equities?

Generally, the thoughts we get from many of our clients is that the U.S. stock market is overvalued. Over the last year, however, many may not realize that the “overvaluation” of the market 12 months ago was even more pronounced than it is today. See this price to earnings ratios (P/E) chart since 2017:

Note: This is the S&P 500 index price to earnings (P/E) ratio.

Why did this occur? Simply speaking, the earnings of companies ended up catching up while revenues remained strong due to waning COVID lockdown measures coupled with unprecedented government stimulus. Treating 2020 as somewhat of an outlier due to COVID factors, today’s P/E ratio remains elevated relative to the last 10 years. 

The question remains whether this elevated P/E ratio actually signals that the U.S. market is overvalued. There are several factors that come into play – low interest rates with expected interest rate increases, pension and institutional wealth funds trying to hit rate of return targets, inflation expectations, and many others. These factors when coupled together paint a much more complex picture of the “why” concerning elevated P/E. But in the end, we will continue to need strong earnings to support higher prices. In 2022, we see more headwinds due to an anticipation of higher rates, potentially pouring some cold water on the inflation heat and possibly slowing growth as a result. We also believe that there should be tailwinds – at some point, we will emerge from COVID, leisure activities and travel will increase significantly, and taxation on businesses and individuals will likely remain low until at least 2025 absent any unexpected legislation. 

Low-Interest Rate Environment Matched with Expected Low Returns in Bonds

The Fed has been quite transparent about its plans to raise interest rates throughout 2022 in a response to inflationary pressures and potential overheating of the U.S. economy. While we have been through a long-term decline in interest rates over the last thirty years, there have been periods of time where interest rates have been on an upward trajectory, albeit relatively short ones. One more recent period of time where this occurred was in 2018 when the 10-year treasury rate increased over 12%. In looking at how this increase in rates affects bond prices and yields, we can reference the following chart:

Note: BND used to represent the total bond market, BSV used to represent short-term bonds.

Some takeaways from this:

    • The 10-year treasury did not move in a straight line during the year. Despite this, dividend yields from the two ETFs (used as examples), steadily climbed throughout much of the year.
    • As yields climbed, prices fell, which is the conventional wisdom we learn in economic textbooks. Keep in mind that the 10-year treasury started in the 2.5% range in 2018 and crested over 3%. We ended 2021 with a rate of around 1.5%. Here is a data source for treasury rates.
    • Short-term bonds weathered the higher interest rates better than longer-term bonds, which again would fit conventional wisdom. Additionally, shorter-term bonds were less volatile than longer ones during this period.

As we look at 2022 and beyond, we expect interest rates to keep climbing throughout the year, though it is unlikely the climb will be in a straight line. One strategy to employ for the year would be to keep the duration of your bonds short if interest rates do indeed rise, and perhaps consider using some inflation-protected bonds if you expect inflation to continue to remain high. The issue with that is we are starting from a very low-interest rate – the 10-year treasury (which would be considered intermediate bond duration) is still well below 2% at the time of this writing in early January. As rates rise, bond prices will fall, so it is highly unlikely we will see much in the way of gains.

Another strategy is to move into higher-yielding bonds – perhaps considering lower credit quality or floating rate bonds to juice up yields. The issue with going too far down that path is simply that a decrease in credit quality will lead to taking higher risk in your overall portfolio, and aren’t bonds supposed to be your hedge against falling stock prices and your way to diversify? 

If you are gathering from the above comments that this is a tough environment for bond investors, you would be correct. Starting from such low yields, historically speaking, with the prospects of increases in interest rates, would portend a less than rosy outlook for bonds in the near future.

Uncertainty of Wage Growth

Nearly 70% of our GDP measurement ends up coming from consumer spending. When we emerged from the depths of the pandemic, as states started to reopen, there was a significant shortage of workers to fill job openings. Resultantly, we saw a significant increase in wages that persists today (and at the bottom of the wage ranges, this started before COVID). This is the good news. 

The bad news is this is only one side of the equation, as we care more about “real” wage growth, defined as wage growth minus inflation. Unfortunately, we have seen inflation quickly overwhelm wage gains. As we all have felt the higher prices at the pump and in our grocery stores, we all hope these will be temporary

If Americans are feeling the effects of inflation, several things could happen:

    • Purchases could be delayed or canceled due to the increased costs of items.
    • Substitutions could be made to minimize the impact of price increases, for example, instead of buying the organic strawberries you choose to buy non-organic or you substitute pork for beef.
    • Purchases are accelerated with the thought that prices will be higher in the future. For example, ordering countertops from Home Depot now instead of waiting a few years.

Aside from the accelerated purchases, cancellations or substitutions will be negative for GDP growth. Additionally, the greater wage uncertainty one has, the less “risk” they are willing to take when making purchases. If “real” wage growth isn’t so real, despite the likely outcome of prices being higher a few years from now, a family may not choose to buy a home, automobile, or other higher-priced items just based on the perception that they won’t be able to maintain their purchasing power. 

So What Does This Mean for 2022?

We don’t believe in producing a market forecast, as it is a fool’s errand. What we will posit is that we expect greater volatility, as the first few days of 2022 would indicate, while returns may come a bit harder than 2021. As it stands, to score runs right now we may have to settle for some small ball and lots of singles – for those baseball fans out there. For advisors, it means that we have to remain open to considering investments beyond the S&P 500, as we always have. In any market, there will always be opportunities. Perhaps this can be found in considering a rotation towards value-oriented U.S. stocks, a more substantive allocation to non-U.S. stocks, or potentially, more tangible assets such as commodities or real estate. In the end, we all must remember that time frame and time in the market are inherently crucial to long-term success, so review these items with your advisor in your strategy meetings to see how it applies to you specifically.

Clint Walkner

2022 Investment & Market Outlook Guide

Clint Walkner’s piece is part of Walkner Condon’s 2022 Investment & Market Outlook Guide, a comprehensive reflection of 2021 and glimpse at the factors impacting the year ahead in 2022.

Fixed Income: COVID recovery, economic growth are key factors in 2021

Fixed Income: COVID recovery, economic growth are key factors in 2021

The novel coronavirus brought upon us unprecedented shutdowns and economic turmoil in the first half of 2020, and there was no greater impact on righting the ship than the Federal Reserve. In the midst of our economy grinding to a halt and our GDP cratering, Federal Reserve Chairman Jerome Powell brought interest rates down to zero, and the central bank used a number of different tools in its repertoire to help the struggling economy and businesses navigate the shutdowns. These moves helped to prevent an even more dire situation, but it has left investors that rely on fixed income in a precarious position in the trade-off for receiving steady income from your money vs. the risk of capital to reach for a higher yield. 

2020 returns on fixed income securities were strong due to the actions of the Fed. When interest rates drop, the price of bonds goes up, and you tend to see higher returns. It does not seem likely that the Fed will raise interest rates in 2021, and that could be as far out as 2023 if the economic impact of COVID-19 continues to dampen the U.S. economy. This portends a positive outlook in the short term for bond investors, but yields on fixed-income investments will more than likely be lower for longer due to the outlook for short-term rates. This does not mean that fixed income will not be an important part of a diversified portfolio for 2021 and beyond, however.

Money-Market and Cash Deposits

The short-term road for cash and money market investments looks bleak as the short-term rates are expected to be kept at, or near, zero moving forward. It will be difficult to earn a meaningful return on these deposits, but they will continue to be attractive for defensive investors who do not want to lose principal because of the lingering economic uncertainty due to the coronavirus, a new administration, and new Congressional economic policies.


With the economy continuing to recover and the COVID-19 vaccine in the process of being rolled out, we should see the yield on the 10-year treasury increase. The Federal Reserve looks to normalize this yield as the economy strengthens, seeking to control inflation. If inflation increases as it is expected to, we could see intermediate yields rise and reach a range of 0.5% to 1.6%. Short-term rates will more than likely remain at or near zero as the Fed wants to continue to prime the pump of the economy and keep money cheap.

Graph of the 10-Year Treasury Yield Comparing Nov. 2019 and Nov. 2020

Source: Bloomberg. 10-Year Treasury Yield and a Proprietary Multifactor Fair Value Model of the 10-Year Treasury, using JPMorgan Global PMIs, Inflation Swaps, and the Term Premium. (USGG10YR Index, MPMIGLMA Index, FWISUS55 Index, ACMTP10 Index). Using monthly data as of 10/31/2020. Past performance does not guarantee future results.

This should help businesses borrow to remain in business and even expand as the economy continues to recover. Treasuries are attractive because they are safer investments due to the fact that they are backed by the full faith and credit of the U.S. government. In the risk-reward world, this causes them to have less of a return than other fixed-income investments that require more return for the inherent risks of investing in them. Their safety and relatively modest returns should continue throughout 2021.

Treasury Inflation-Protected Securities (TIPS) can be helpful to fixed income investors in 2021 and beyond to protect against inflation risk during a rising interest rate environment and can be an important part of a fixed-income portion of a portfolio. With short-term rates having nowhere to go but up, they should be a good inflation hedge.

Corporate Bonds

2021 should create an opportunity for investment-grade corporate bond investors, but it is important to look to keep duration shorter in these investments. Duration is the time it takes for a bond to return the coupon and principal back to an investor; it can fluctuate based on interest rate changes and can be managed through diversification and bond-laddering. Credit quality is important as well because ultimately, these investments have the risk that the bond issuer could become insolvent—though at least the bondholders are ahead of the shareholders in line for payment in a bankruptcy proceeding. If you are looking for higher-yield bond returns, then you will more than likely need to invest in issuances that have more credit-quality risks. With bond yields being lower due to lower interest rates, it will be important to guard against overexposure to these investments in the search for a higher-yielding portfolio.

Global Bonds

The global bond outlook for 2021 will have a lot to do with how the valuation of the dollar moves. If the dollar weakens as it did at the end of 2020, then we should see strong overall returns in this asset class as the native currencies strengthen. As the U.S. government continues to stimulate the economy with an influx of borrowed money, and the Fed’s policies remain dovish, global bonds should become more attractive for foreign investment to fill the gap due to low yields and returns on U.S. debt. Improving global economic conditions as we come out of the coronavirus pandemic, in addition to accommodative central banks, should make this an attractive asset class in 2021. However, there is still more risk in global bonds than in U.S.-backed treasury bonds and other higher-quality issuances.


It is difficult to predict how soon the U.S. and global economies will recover from the COVID-19 pandemic. But, if there is continued economic growth, investors could find yield and returns in fixed-income. It could be a choppy year in these asset classes as central banks continue to use their tools and programs to stabilize the economy, so it will be important to monitor quality and diversify your fixed-income holdings.

Jonathon Jordan, CFP®


This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.