What’s In Store for 2022?

            Where did 2021 go?  Much can and has been written about the cultural, political, and social challenges facing our country last year, not least of which is the ongoing global pandemic.  Despite these challenges, the global equity soared to an increase of 16.7%¹ while the US-based S&P 500 returned 27%. 

​As 2021 progressed, it became quickly apparent that fiscal and monetary stimulus facilitated a seemingly insatiable appetite for consumer goods, with profits rising 45%, the highest mark since the gauge was started in 2008.²  The Fed’s accommodative actions were so effective that inflation quickly became the headline by mid-year.  Looking to 2022, what follows is a brief synopsis of the factors worth considering:

1. Inflation and Federal Reserve action: The Federal Reserve Open Market Committee (FOMC) is charged with providing price “stability, maximum employment, and moderate long-term interest rates.” Among its many tools to stimulate or suppress economic activity is monetary policy.  In the interest of brevity and at risk of insulting your intelligence, monetary policy can be summarized as the Fed’s action of buying or selling bonds to increase/decrease the money supply in the open market.  More dollars in the system leads to lower borrowing costs and stimulates consumption, borrowing, and capital investment at nearly all levels.  If the Fed goes too far with “easy money” policies, inflation can ensue. To that end, the Fed forecasts an accelerated tapering of accommodative policies and increase short-term rates up to three times in 2022.³

Criticisms notwithstanding of the Consumer Price Index as an accurate gauge of “main street” inflation, it is widely regarded as the accepted barometer of broad price movements for goods in the US economy.  The reading had been stubbornly low for the last decade when measured against the Fed’s target rate of 2-3%.  The eye-popping 2021 YoY measure of 6.8% reminds investors that cash loses its purchasing power when not actively participating in the market (short-term savings aside).  The Fed will need to walk a tight rope to not induce a recession while simultaneously preventing rampant inflation.

One interesting vignette worth mentioning is that the market is resilient, and it tends to drift above and below “the mean”.  This can lead to dramatic corrections in whichever market worth analyzing.  Take for example the company “Top Glove Corp” – a Malaysian company which is the world’s largest maker of disposable gloves positioning it well to supply PPE at the height of the pandemic.  As the graphic would indicate, shortages can lead to gluts as markets respond to changing conditions and supply/demand dynamics.⁴  Should bottlenecks at ports and supply chains ease, this could bring a relief to the current inflationary environment through a shift in the supply curve.

2. World economic growth projected by IMF to be 4.9% which is below the 2021 rate of 5.9%, but well above the 3% average rate. Growth is slowing, but not slow.⁴

3. Consumer confidence: “The cure for high prices is high prices” – consumer confidence is slowing likely due to inflation expectations, but not necessarily a “tell-tale”. Otherwise stated, it is reasonable that in response to the inflationary environment, consumers telegraph muted demand, however, actual demonstrated consumption is not always in lockstep with consumer confidence forecasts.  Wages may adjust upwards, and prices may recede bringing equilibrium back to consumption. 

4. Labor market. Resiliency in the labor market has been a bright spot in the pandemic recovery.  As of this draft, payroll company, ADP, announced a dramatic increase of 807,000 private sector jobs added from November to December.  Uniquely, workers seem to have greater bargaining power as companies seek to fill much-needed positions.

5. Profit margins, often referred to as the “mother’s milk” of stock market returns, remain strong but could be hampered by higher input costs. So far, higher labor costs have not yet hampered margins. It is unlikely that 2022 experiences an encore of ‘21’s performance, however, “analysts expect(ed) earnings growth of 6.2% for Q1 2022, and 4.1% for Q2 2022.”⁵

As investors, we must keep top of mind that the market is a predictive mechanism that “discounts” future expectations to present value.  Otherwise stated, all available information to the market, including future expectations, is sufficiently reflected in share prices – this hypothesis of “efficient markets” represents the basis of our conviction that markets cannot be consistently timed for entrance and exit and serves as a reminder that while markets are efficient, they are not always predictable as new information is constantly introduced and adjusting discounted future expectations. 

As I reach the summary paragraph of this commentary, I realize that I’m turning into a broken record as my comments for 2022 are largely in line with those for 2021, in which I wrote:

“In summary, prognostications appear to be cautiously favorable for the potential for additional global growth but are customarily tempered by the potential for very real risks that could threaten the rosy outlook…”

  We are well-served to be reminded of what we can control.  At risk of repetition, you are likely familiar with a few refrains:

1. Volatility is an expected experience of owning securities – this truth is not simply contained to the stock or bond market, but is a reality for commodities, real-estate, currencies, and other asset classes albeit to varying degrees. Federal Reserve actions increasing short-term lending rates historically roil equity markets in the short-term as the reality of higher borrowing costs are absorbed and factored in growth expectations.

2. We believe that allocating to these various asset classes is the key to managing risk. “Diversification” is often applied at the micro level (within the same asset class – stocks for example), but it has relevance across the broader spectrum of asset classes.

3. Buying at market peaks and selling at troughs, while an understandable temptation, exemplifies the emotional nature of investor psychology and behavior. Our fear of loss is much stronger than our desire for gain, but both fear and greed can lead even the most seasoned/savvy investor astray.  Discipline is the key to long-term wealth building, and one of the best things we can do is to rebalance a properly allocated portfolio during periods of volatility.

4. Having a cogent, action-able plan provides the guiding light and counterweight to urge to sell/buy based on emotional response.

We continue to assess the investment landscape and are conscious of the fact that rising bond yields will likely strain returns in the short run, however, we are convicted that prioritizing lower duration, mid-to-high quality fixed income remains the best way to lower overall risk when appropriate for clients.  While we do not subscribe to “sector rotations” I believe market conditions are primed to experience expected return premiums in the value and small cap spaces.  Regardless, maintaining a disciplined and diversified approach is our chief responsibility in managing client portfolios. 

Thank you for your confidence in our service to you as your trusted financial advisors.  We welcome an opportunity to speak with you through the medium of your choice.