Recap: As we close the books on 2021 and begin 2022, we’d like to wish everyone a Happy New Year! 2021 was another stellar year for the markets, although there were many hurdles along the way. We began the year with optimism around vaccines preventing the spread of Covid19, however a new administration coming to office left questions about how the recovery would be handled going forward. The Biden administration followed up Trump’s 900 billion stimulus package at year end with a 1.9 Trillion dollar stimulus package in the second week of March. This coupled with easy monetary policy led to both very healthy consumer and corporate balance sheets. Spending was robust as consumers had more money in their bank accounts, higher portfolio values, and increasing home values. However, the pickup in economic activity along with supply chain issues has led to historically high price levels and a fear of inflation that was nonexistent in the previous economic recovery. On paper markets had a smooth ride with minimum pullbacks throughout the first half of the year. However, beneath the surface were numerous rolling corrections. First was technology and higher valued companies as the ten-year treasury soared through the first quarter. Thereafter those companies rebounded as rates steadily moved lower along with the cyclical stocks. Since then, it has been a coin flip on any given day which would take the reins.
Powell continued his transitory stance for most of the year even though inflation readings were the highest we have seen in thirty years. The Fed wanted to see the employment numbers improve further before tapering their bond buying program. In our managed portfolios we carried an overweight position to equities and specifically cyclical stocks throughout the first half of the year. We slightly reduced our cyclical exposure in July to increase our exposure in the technology and healthcare sectors. As September approached uncertainties were increasing around the debt ceiling, inflation, and monetary policy, and thus it was a prudent time for us to reduce our equity exposure in anticipation of a pullback. The pullback came sooner than anticipated on a continuation of the inflation narrative, weak jobs data, fear of Evergrande contagion, and conflict in Washington. We took advantage of the pullback and rode the gains until the last few days of October. Stocks valuations were leaning toward the high side once again, so we again reduced our equity exposure to our longer-term targets. Toward the end of November volatility struck again with the spread of the Omicron variant. The panic appeared overdone as the variant appears to be less severe, although faster spreading. The Fed used the variant to pivot to a more hawkish stance and sped up their planned tapper timeline. They stated that the Omicron variant may prevent supply chains from resolving as quickly as anticipated and creates further uncertainty around inflation. The market took it in stride and had a “Santa Clause Rally” into year end.
Outlook: 2022, although expected to be strong, will fail to reach the economic heights of 2021. The economy will be shifting from a stimulus fueled boom to more normalized economic growth. GDP is expected to far exceed trend growth at 4% with the faster growth occurring in the first half of the year. We could see spending shift more toward the service sector as pandemic fears subside. On the employment front we should see further improvement, however the labor market is quite tight as the unemployment rate has declined substantially this year. Corporations are still having trouble filling jobs with 4 million less people employed than before the pandemic. 1-2 million may be attributable to baby boomers exiting the workforce for permanent retirement, but the remaining should re-enter the work force as their excess funds decline. This may be sped up by the expiration of the child tax credit this month. However, if the participation rate remains low it could lead to further wage growth which will add to overall inflationary pressures. This along with supply chain constraints and excess demand will likely keep inflation high for the first half of the year before leveling off. It is our belief that inflation will be higher than we saw during the last economic recovery but remain toward the lower end of historical ranges. Higher wages and higher rent assigned to housing are two components that tend to be stickier. However, with supply chains starting to recover as well as longer term disinflationary economic trends we should start to see a normalization by year end. These trends include baby boomers continuing to exit the work force, globalization, and increased productivity through technology enhancements.
S&P earnings are expected to come in near high single digits with the consensus by LPL Research of year-end estimate for the index to be between 5000 and 5100 which signifies mid to high single digit returns. Although it will largely depend on how the economy progresses and monetary/fiscal policy. As of right now the market is anticipating quantitative easing to end in March and could see a rate hike as early as the second quarter with three anticipated for the year. We think two rate hikes are more realistic with the first one starting in the second half of the year. Overall, our investment team is bullish for the year and sees the economic progression in mid cycle. We may see value outperform in the first half of the year and will retain our slight overweight to cyclicals, transitioning to higher quality and growth companies in the second half. We are currently near our strategic (longer term) allocation targets. We remain flexible with our positioning and if we see signs of economic growth slowing or uncertainties rising, will reduce our equity exposure.
If you have any questions about your portfolio or the markets, please don’t hesitate to give our office a call.
I hope everyone has a great 2022!
Research material prepared by LPL Financial LLC.
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