07 Jan JANUARY MARKET UPDATE 01.07.22
JANUARY 2022 MARKET UPDATE
When I wrote our 2020 Year in Review at this same time last year, clients were asking why stock markets continued to rise despite COVID and a myriad of uncertainties. After another incredible year for stocks, +20% or more, the same questions are percolating.
How long can this last? When will it end? Are valuations too high? What will be the selloff trigger?
In response, I point to some similar themes as last year for the continued upward trajectory – strong earnings, above average Gross Domestic Product (GDP), low interest rates, few good alternative investments, government stimulus and the ongoing benefits of COVID relief through vaccinations and therapeutics. On a personal level, some things have also not changed: my kids will go back to school tomorrow with masks and my youngest maintains that being “positive” is a bad thing! Joking aside, I know they were thankful for simply being back in school and returning to some sense of normalcy in their everyday lives.
From an investment perspective, the last few months have been anything from normal bringing major changes and subsequent challenges in the new year. The largest being the Federal Reserve pivoting on its inflation position, fast forwarding the timetable for tapering (a fancy way of saying buying fewer bonds and assets) and increasing short-term interest rates. Although we anticipate rates rising across the yield curve in 2022, we forecast a continued overall lower rate environment versus long-term interest rate averages. One of my greater concerns for the foreseeable future, which I’ve been sharing in client meetings, is low and potentially negative real returns for bonds. Many investors will be surprised to learn high quality bonds had negative total returns in 2021, which has been a rare occurrence over the past 20 years. As rates continue to rise, bond prices will continue to stutter, and equity valuations will come under additional scrutiny.
Although Omicron is making headlines in January, the new bogeyman in the media is inflation. Since registering 6.8%, the largest annualized rate increase over the last 40 years, inflation remains justifiably top of mind for consumers and investors alike. Thankfully, we anticipate this rate to moderate in 2022 as energy prices readjust, consumer spending normalizes, and supply chains catch up. As I remind my colleagues in our strategy meetings, inflation is not necessarily a negative for the market, particularly if we are producing commensurate growth rates. For example, if GDP can run 3.5% or higher and inflation subsides to 3% or less the Federal Reserve (and we as investors) should feel comfortable with the trajectory. In summary, we anticipate lower inflation than 2021 but likely higher than what we have experienced over the last decade. I reinforce we are not predicting runaway inflation like was evident in the 1970s.
Unfortunately, I’m not a savant on the timing of market adjustments but I will opine on some likely scenarios for the coming year, how we are positioning our portfolios and areas on which we will focus.
- Bond returns will continue to be challenged as rates continue to rise.
- Maintain a moderate overweight position to stocks and underweight to bonds.
- Inflation will moderate towards the latter half of the year but remain elevated versus recent history.
- Maintain overweight position to Real Assets like Real Estate and Natural Resources.
- GDP, economic data and company earnings, although decelerating from lofty 2021 numbers, will remain well above average.
- Further supports keeping an overweight position to stocks.
- The world does a better job of living with COVID despite uncertainties of future strains.
- Favoring cyclical companies and those that will benefit from consumer spending in a post-pandemic world.
- With Build Back Better in its current rocky state, congressional stimulus wanes.
- This may be a drag on certain sectors of the economy, but overall liquidity in the market remains strong given increased government support over the last two years.
- The Fed accelerates tapering of bonds and other assets and likely increases short-term rates 2-3 times.
- Staying underweight bonds, overweight in high yield bonds (we like preferred issues in this asset class) and keeping duration moderate.
- Anticipate stock market returns to normalize, with an increased likelihood of a 10% correction. This is not to say we will end the year negative, but the likelihood of some type of correction has increased on the back of three significantly above average years for stocks.
- Still prefer stocks even with a correction given the erosion of bond prices as rates rise. Lack of better options continue to be supportive.