Looking for the return to normalcy in 2022? Expectations could be the key.
2021: the Economy, Americans, and the Markets
During 2021 the economy continued its steep, rapid recovery from the deep, pandemic recession to an economy with close to 5% GDP growth and near full employment. Corporate profits soared, innovation and entrepreneurship accelerated, and business investment increased productivity. The underlying economy exited 2021 in a robust position.
At the same time, many Americans entered 2021 feeling the US was headed in the wrong direction. Even though workers had gained new power to change jobs and seek higher wages, the Great Resignation was often attributed to burnout or workplace dissatisfaction. As small businesses attempted to hire and rebuild, the leisure and entertainment industry was repeatedly thwarted by Covid variants keeping participants away. And consumers were confronted by record high prices as they sought to assuage frustrations with unavailable goods caught in supply chains woes.
If there was one good thing Americans enjoyed about 2021, it was the markets.
The US stock markets surprised nearly everyone by trudging higher for most of the year. The bears couldn’t muster a downturn greater that 6% in all of 2021, making the year one of the calmest on record. The S&P 500 return for 2021 was 26.89%, with five year average annual returns coming in close to 17.5%.
Will the markets continue to see what Americans couldn’t this year? Or have the markets gotten ahead of themselves?
The economy and market performance are often built on expectations. Here are three examples that can be applied to 2022.
Expectations and Inflation
Economics 101 teaches that there are two types of inflation: Demand Pull (too much demand and too little supply; resulting in price hikes) and Cost Push (wages and raw material cost increases, forcing business owners to charge more). Both factors are occurring today. But expectations also play a huge role in the future of inflation. If consumers and business owners expect inflation to rise, that belief can become a self-fulfilling promise. For example, if consumers expect higher inflation in coming months and believe that goods will cost more in the future, they will likely buy cars, stoves and other things now, thereby exacerbating the current demand problem.
The Federal Reserve controls the levers to respond to runaway inflation. Markets are extremely concerned that hot inflation will force the Federal Reserve to tighten monetary policy faster than expected.
Expectations and the Bond Market
Bond market performance is driven by interest rates. As interest rates rise, the value of underlying bonds fall, clipping returns. If interest rates rise slowly, bond markets can usually absorb most of the increases, especially from low interest rate levels like those that exist today. Jerome Powell, the Federal Reserve Chair, is working hard to reassure bond investors that the Fed will act in a measured fashion to tamp down rising inflation. However, if bond traders start expecting the Fed to tighten more quickly (whether the Fed intends to or not), they can send interest rates spiking, wreaking havoc on the markets.
Expectations and Stock Market Returns
Remember the 1990s? Many people thought the good times could last forever. Historically, stock market average returns tell a different story. When market prices become elevated (another form of inflation), they tend to revert to lower returns over time. Equally, when stock prices are super low, they tend to rise, moving towards average historical returns. Timing is not perfect. High prices can stay high for a long time, as low prices can stay low. But eventually, neither the good times nor the bad times last forever.
Valuations are rarely the predictor of immediate market performance. But it is a fair bet that average returns over the next ten years will come down dramatically from current lofty double digit performance. Whether that process starts in 2022, 2023, or some other year, is not yet predictable. However, investors need to adjust their expectations for lower equity returns, to better prepare for their own financial futures.
StrategicPoint Expectations for 2022
Here are some expectations our Portfolio Management Committee has for the coming year. As a reminder – expectations are not predictions or promises. They are assumptions that we use to base our portfolio decisions. We have learned repeatedly, over the years, to expect the unexpected, and will thus monitor these current beliefs throughout the year for recommended changes.
• Economic growth should moderate but remain higher than during the post 2008 economic crisis, despite a likely Omicron driven slowdown in Q1.
• Market returns will likely remain positive, albeit at a more subdued rate of return than recent years. However, the path of rising stock prices could be rockier, as markets assess how well the Federal Reserve navigates the withdrawal of monetary stimulus.
• The Federal Reserve should finish tapering its bond purchases by spring and start raising interest rates by mid-year, carefully monitoring, and attempting to control inflation expectations.
• Bonds should, once again, deliver more ballast to the portfolios than positive returns.
• Supply chain problems are expected to improve gradually throughout the course of the year because of increased capital spending, vaccinations and consumers shifting back to services from buying goods.
• Consumer spending should be able to support continued economic expansion, due to strong personal balance sheets and accumulated savings.
• Labor shortages will likely continue, thereby keeping wage pressure on prices.
• Inflation should gradually retreat, settling at around 3% – 3.5% once supply chain issues are better controlled. This level of inflation will not be high enough to meaningfully stifle growth.
• Corporate earnings should remain strong, but be gradually reined in by rising interest rates. Ditto with the housing market.
• Investors could remain anxious as Covid lingers, disruptions continue, and the Fed gears up for monetary tightening.
In sum: 2022 starts with a strong economic base topped with a layer of unpredictability and volatility. Overall, with positive economic growth and little talk of a recession, the markets are expected to deliver a year of modest, constructive returns.
We hope all of you find financial stability and happiness in 2022.
Betsey A. Purinton, CFP®
Chief Investment Officer
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference. Certain statements contained herein may be statements of future expectations and other forward-looking statements that are based on SPIA’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. In addition to statements which are forward-looking by reason of context, the words “may, will, should, expects, plans, intends, anticipates, believes, estimates, predicts, potential, or continue” and similar expressions identify forward-looking statements. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements. SPIA assumes no obligation to update any forward-looking information contained herein.