The Week in Review: January 3, 2022

2021—A Grand Economic Reopening, a Gilded Age for Investors

The reopening of the economy, new vaccines, the pandemic, strong economic growth, rising oil and home prices, and a burst of inflation were among the major events last year.

For investors, 2020’s advance spilled over into 2021.

Simply put, economic growth translated into much-better-than-expected corporate profits, according to Refinitiv. Low interest rates and low Treasury yields added to the luster of equities.

Fig. 1 reviews the best-performing bull markets since WWII, including the current run. As the graphic illustrates, the current bull market, which began in late March 2020, is off to a fast start.

Ultra-low interest rates, very easy money from the Federal Reserve, and stellar corporate profits have more than offset inflation fears and economic worries about the ongoing pandemic.

Overall, the economic expansion has been robust, but it has not benefited all sectors equally, as highlighted in Fig. 2.

Stimulus money favored consumer goods. Pent-up demand is aiding services, such as recreation and travel, but it continues to lag. And that leads us to this year’s burst of inflation.

We Haven’t Seen This Type of Inflation Since the Late 1940s

This is not your father’s inflation. It’s your grandfather’s inflation. When millions of troops came home after World War II, they demanded everything from appliances to clothing. Further, a wartime economy that favored production of military equipment over consumer items led to rationing and pent-up demand for consumer goods after the war.

It took time for the economy to adjust to peacetime production, and prices temporarily spiked.

Today, we have trillions in stimulus, a reopening of the economy, and a shortage of some goods tied to global supply chain woes. In other words, strong demand collides with supply shortages. Mix in a super easy Fed, and inflation hit its fastest pace in 40 years.

Peeking Ahead at 2022

“It's tough to make predictions, especially about the future.” —Baseball manager/philosopher Yogi Berra

Recognizing the obstacles faced when peering into the future, let’s dust off our crystal ball and touch on some of the key issues as we move into 2022.

China’s fast-growing economy has been fueled by debt, and real estate is no exception. During the fall, cracks appeared. Real estate is a big part of China’s economy. If it crumbles, expect it to ripple through the global economy. However, that’s a big “if.” The odds of a 2022 real estate collapse in China probably aren’t high, but what happens in China bears watching.

Inflation is uppermost on the minds of many folks. Is inflation set to peak early in the year? Peaking isn’t the same as price stability. It simply means price hikes aren’t accelerating as quickly. Depending on the trajectory of COVID and lockdowns in various countries, most analysts believe supply chain problems will ease sometime next year. But rising wages may become a problem. If so, businesses could raise prices to compensate for higher costs.

If we avoid a wage-price spiral, economic growth moderates, and supply chain woes recede, the rate of inflation will probably ease at a quicker pace.

The Federal Reserve has taken notice of price increases. It is unwinding its bond-buying program at a faster pace and is considering three rate hikes in 2022. Early in 2021, Fed Chief Powell was fond of saying that he didn’t expect any rate increases through at least 2023. The course of inflation will play a big role in how aggressive the Fed may get.

Despite much higher inflation this year and talk of a more hawkish Fed, the yield on the 10-year bond remains incredibly low, finishing last year at 1.52%, per the U.S. Treasury Department.

Robust economic growth, higher inflation, and a less dovish Fed (and fewer Treasury bond buys by the Fed) should be translating into much higher yields. That hasn’t happened—see Fig. 4.

Either bond investors are expecting inflation and the economy to slow next year, or there have been fundamental changes in the bond market that are holding down yields.

Whatever the cause may be, low yields are supportive of stocks when the economy is expanding. A jump in yields could create some market volatility.

Finally, how will the pandemic play out? Will new variants surface? The Delta variant temporarily slowed growth in the late summer, but market reaction was muted.

As we enter 2022, Omicron is getting attention. U.S. cases are rising, and some folks may hesitate to congregate in public places, which could dampen growth. Yet we’ve seen limited market reaction so far. A late December survey by The Wall Street Journal reflected concerns of a temporary global slowdown in early 2022.

So far, local and state governments have been reluctant to impose significant new restrictions.

New Highs and Perspective

Fig. 5 illustrates the number of new closing highs for the S&P 500 Index in each respective year. In 2021, we had 70, which is on top of 33 new highs in 2020.

New highs can tempt some investors to back away from equities or wait for a big pullback to put new cash to work. Others are tempted to become aggressive. We may see a pullback, but new highs are typically the hallmark of a bull market, as illustrated by Fig. 5.

Yet, we recognize that downturns are a part of investing. Based on your goals, circumstances, and risk tolerance, we craft portfolios to help manage risk, but we can’t eliminate risk.

If one trades the fear of selloffs for a savings account, one won’t participate in the long-term upside that stocks have historically offered. Conversely, take on too much risk and you may experience sleepless nights in a swift downturn.

If life events have forced you to rethink your goals, let’s talk. If not, adherence to one’s financial plan and a long-term focus have historically been the straightest path to reaching one’s financial goals. We may see volatility, but predictions are simply educated guesses. If history is our guide, selloffs are followed by rebounds.

From all of us, we wish you the best of health and happiness throughout 2022.

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