February 2022 E-Newsletter: 2022 Financial Outlook
Jonathan M. Gardey, MBA, CFA®, CFP®
President and Chief Executive Officer
2022 Financial Outlook
The start of a new year is the traditional time to reflect back on the past year and to contemplate on the year to come. The following is our commentary.
LOOKING BACK AT 2021
The year 2021 was a year of living with and adjusting to COVID, continued political division, supply chain issues, employee shortages, and increased demand for virtually everything as lockdowns were relaxed. The biggest news of the year was the break out of inflation which ended the year at an annual rate of 7.0%, the highest rate in 40 years. This rise in inflation was driven by a quadruple whammy of product shortages, employee shortages, and record levels of fiscal and monetary support.
Despite this breakout of inflation, markets in general did very well:
Stock Market Returns:
World stocks (MSCI ACWI All Cap Index): +18%
Dow Jones Index: +21%
S&P 500 Index: +29%
NASDAQ Index: +22%
Russell 2000 Index: +15%
Non-US Developed Markets (MSCI EAFE Index): +11%
Emerging Markets (MSCI EM Index): -2.5%
Bond Market Returns:
Bloomberg Barclays Aggregate Index: -.5%
Non-US bonds (JPM GBI Global ex-US Index): -2%
The negative returns generated by emerging markets stood out during a year of high equity market returns. The primary drivers of these poor emerging markets returns was a combination of rising interest rates in the US, slowing growth and regulatory clampdowns in China, low COVID vaccination rates, and a strong US dollar.
In regards to inflation and stock investments, the old rule of thumb, a little inflation is good for stocks but a lot of inflation is not, held true. For 2021, inflation was at a level that was supportive of rising stock prices. In addition, market volatility was very subdued throughout the year which was a nice relief following the volatility in 2020.
The negative bond market returns in the US was primarily the result of rising interest rates and the rise of inflationary concerns. The US 10 Year Treasury Note rate rose from 0.93% to 1.52% during the year. This was the largest increase since 2013. In our view, 2021 started out with unsustainably low rates so this increase, while painful to bond investors, does not imply future economic trouble.
LOOKING AHEAD TO 2022
In contrast to 2021 where COVID was the focus, we believe the Federal Reserve’s shift in monetary policy will be the primary driver of the markets and the economy in 2022.
In late 2021, the Federal Reserve transitioned from focusing primarily on achieving full employment to targeting the breakout of inflationary pressures. The Fed’s long-term goal is price stability (low inflation) which they define as 2% inflation. For many years, inflation had been running consistently below this 2% target. Historically, the Fed would aggressively raise interest rates, typically referred to as tightening, to prevent inflation from overshooting this 2% level. The intended effect of this policy was to prevent inflation from ever reaching 2%. In August 2020, the Fed changed this policy to target an average inflation rate of 2% over an undefined timeframe.
The Fed’s initial response to the rise of inflation in 2021 was to call it “transitory” due to their belief that it was caused by temporary disruptions in the economy; resulting from the monetary and fiscal responses to the COVID pandemic. This view of inflation turned out to be erroneous. In addition, their new policy of targeting an average inflation rate did not call for immediate action. When the Fed’s transitory perception changed in November 2021 the Fed announced they would start tapering their monthly bond purchase program, which was put in place at the start of the COVID pandemic to support the economy. Then, in December, the Fed announced they were ending the monthly bond purchase program in March 2022, three months earlier than planned due to their increased inflation concerns.
The goal of these changes was to put the Federal Reserve in a position to start raising interest rates in 2022. Raising interest rates is the primary tool the Fed uses to fight inflation. At the beginning of 2021, the market’s perception was that the Federal Reserve would not start raising interest rates until 2024. By the end of 2021, the market’s perception had changed; the Federal Reserve would raise rates three times in 2022. This was a dramatic change.
The notes of the Federal Reserve’s December meeting were released in early January 2022. These notes indicated that consideration was given to actively shrinking the Fed’s bond portfolio accumulated through their supportive monthly bond purchase program. This was a potential change in policy that the market had not considered and would be equivalent to additional tightening. Shrinking the Fed’s bond portfolio, along with raising interest rates, would position the Fed to fight inflation more aggressively than the market had considered. This news subsequently caused market volatility to increase.
While unfortunately COVID is here to stay, our view is the Fed’s policy actions that will unfold during 2022 and their subsequent economic and market impacts, will be the biggest driving force in regards to inflation, interest rates, employment, company profitability, and stock and bond market returns. The Fed seems to be pivoting to directly address these inflationary pressures. We believe they will be aggressive in their actions and will work overtime to prevent further increases in inflation.
The Conference Board’s1 2021 forecast for US economic growth is 5.6%. The University of Michigan’s 2022 forecast calls for a cooling of this growth to 4% due primarily to supply-chain difficulties and another pandemic wave. We see this combination of good economic growth and controlled inflation supporting stock markets in 2022. While short-term interest rates will most likely rise during 2022, we don’t see interest rates rising dramatically due to the resistance of long term trends such as demographics and globalization.
At this point, while uncertainties abound around future Fed policy actions, the interrelated aspects of economic, market, political, and COVID forces will work to cloud our vision of the future. This means discipline will be the best investing virtue during 2022.
Have a wonderful 2022!
Jon Gardey
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1 The Conference Board is a member driven think tank that delivers trusted insights on what is ahead. Their mission is to help leaders navigate the biggest issues impacting business and better serve society. www.Conference-board.org