A Banner Year and a New Year
Overall, 2021 was a good year for investors. The U.S. stock markets performed well due to better-than-expected corporate profits, which were powered by an expanding economy, plus very easy monetary policy compliments of the Federal Reserve.
Low interest rates, low bond yields, and rising profits easily offset worries about the lingering pandemic and much higher-than-expected inflation. Economically, 2021 was not a perfect year. It felt like a day did not go by where we didn’t hear about COVID, inflation, supply chain, or labor market issues.
Between foreign country’s zero-COVID policies, U.S. employees testing positive for COVID, not enough truck drivers and port workers, almost every industry has felt the supply crunch. As the vaccines become more available in less wealthy nations, and global natural herd immunity builds, inflation and the supply chain may begin to normalize in 2022.
While inflation affects most industries, only 8 of 26 CPI categories are significantly contributing to the high overall average inflation rate of 7%. The included chart from the Bureau of Labor Statistics illustrates where inflation is and where it isn’t.
The labor market contracted last year as we believe COVID pushed many of the younger Baby Boomers into early retirement. In addition, the Great Resignation has made news with record job quit rates, but there have also been record job openings for job seekers. Interestingly, job layoffs are at record lows.
COVID has allowed many U.S. workers to reexamine what is important in their lives and nudged them to seek careers aligned with their values. Individuals are switching jobs to find better pay, work-life balance, and less stressful employment.
As we look into 2022, what might the new year bring?
After last year’s strong market advance, what might be in store for this year?
Since 1950, there have been 26 years in which the total annual return of the S&P 500 Index exceeded 20%, according to data provided by the NYU Stern School of Business. In the following year, the S&P 500 Index advanced 20 times, or 77% of the time, in line with the long-term average. The average up year was 18.1%, while the average down year was 6.4%.
It’s an interesting exercise, but let’s always remember that past performance is no guarantee of future performance. Each year will have its own distinctions. We could add one more wrinkle. The total return of the index has doubled over the last three years, according to Dow Jones Indices.
What dictates the market’s direction will likely be the economic fundamentals and whatever impacts those fundamentals. For example, what might the Federal Reserve do with interest rates? At the beginning of 2021, the Fed expected no rate hikes in 2022. However, it failed to anticipate last year’s surge in inflation.
As the year ended, the Fed’s new projections, which it released after its December meeting, reflected a forecast of three quarter-percentage-point rate hikes this year. Are those potential rate hikes already being discounted by investors? If inflation fails to ease–or worse, accelerates–could the Fed take a more aggressive posture?
Let’s take this point one step further. Longer-term bond yields have remained very low in the face of a less dovish Fed, high inflation, and robust economic growth. Will we get a reset in 2022? Or have there been fundamental changes in the bond market that are holding yields low? Or do bond investors simply believe inflation and economic growth will slow?
Corporate profits are also a key driver of stock prices. Consider this: If you were to purchase or sell a small business, wouldn’t recent and projected profitability play a big role in the sales price? It absolutely would. The same principle holds for publicly traded companies.
How will the pandemic play out? We’ve seen Delta and we’re now seeing a surge in cases tied to Omicron. The economic impact of Delta was limited, and thus far, investors have side-stepped economic worries about Omicron. But what does 2022 hold?
One more variable that may affect markets in 2022 is the midterm election cycle. History suggests muted returns during these years, with increased market volatility until fall as politicians jockey for power.
The window is closing for Democrats to push through any major legislation, as history also suggests the party in power during midterm elections usually loses seats.
Political uncertainty often has a noticeable short-term effect on markets. As the polls become more predictable as to who will win, markets tend to return to their normal trajectory. But these are just averages, so investors shouldn’t try to time an entry point into the market based on politics.
We’ve posed several important questions that don’t offer easy answers. We may see a pullback in 2022, and we recognize that downturns are a part of investing.
What this means for your portfolio
We will be replacing a long-held international bond position. We have had this fund on our watchlist and have been steadily trimming it over the last year as the increased volatility, underperformance, and internal changes have compromised its ability to meet the needs of the portfolio.
With inflation still expected to be above the Federal Reserve’s target of 2%, we will still maintain an overweight to equities. Even if the Fed raises interest rates three or four quarter percentage points over the year, we don’t see great alternatives.
We are also maintaining our overweight to international equities, as they tend to be more cyclical and should rebound as their economies recover from pandemic related issues. We also feel valuations are more attractive overseas and this could give us a little more cushion if volatility really picks up.
Keep the long-term in mind
Based on your goals, circumstances, and risk tolerance, we craft portfolios that help manage risk. We can’t eliminate risk, but try to place an appropriate level of risk in context within your financial plan.
If one trades the fear of a sell-off for a savings account, one won’t participate in the long-term upside that stocks and other investments have historically offered. Conversely, take on too much risk when the market has been strong, and you may experience sleepless nights in a swift downturn.
If life events have forced you to rethink your goals, let’s talk. Financial plans are not set in stone. Yet, adherence to one’s financial plan and a long-term focus has historically been the straightest path to reaching one’s financial goals. We may see volatility this year. But predictions are simply educated guesses. As we’ve seen in the past, sell-offs, when they occur, are followed by rebounds. Keep this in mind as we navigate the New Year together.
We trust you’ve found this review to be educational and informative. Let us emphasize that it is our job to assist you. If you have any questions or would like to discuss any matters, please feel free to give us a call.
This research report has been prepared by the Centerline Wealth Advisors Investment Committee 2022©