Despite a global pandemic, supply chain issues, low vaccination rates in emerging markets, and a slew of central banks reducing liquidity to fight inflation, stocks performed admirably. With one day left, the S&P and Nasdaq look to post a near 28% return, while the Dow Jones lagged with a still generous 19% advance. Not only did stocks make new all-time highs, but home values also jumped 20% this year. This pushed rents up 18%, the highest increase we’ve ever seen. Wages are catching up and making new highs with a nearly 5% rise this year. The number of jobs open relative to job seekers even set records. We need another 4.2 million new workers just to even things out. Not to be outdone, inflation is setting records as well. It was an amazing year to say the least, and many parts of the world are back in lockdown mode due to Omicron’s aggressive spread.
Although new Covid variants threw a wrench into many forecasts, stocks barely noticed any slowdown. While emerging markets’ central banks raised rates in an effort to curb inflation, developed economies, namely the United States, Europe and Japan, showed minimal concerns and kept pumping cash into markets. Time will tell if they let things run too hot for too long; next year will finally see some action to pull the proverbial punch bowl. For now, easy monetary conditions helped raise asset class prices and propel consumer net worth to record levels. The U.S. consumer is strongly positioned with respect to assets, balance sheets and spending capabilities. Government handouts, low interest rates and Fed balance sheet expansion certainly helped the upper echelon obtain more wealth over the past two years than expected.
After the last election, some Americans were starting to believe in Modern Monetary Theory, which contends that strong countries can print and spend unlimited money. Following a doubling of the Federal Reserve’s balance sheet, expanded Government handouts and rapidly rising inflation, finally some common sense is appearing. Inflation is the #1 concern for many investors, and therefore, voters. The Fed is reacting to higher inflation and by March will stop purchasing new bonds. After that they are likely to increase the Fed Funds rate. Inflation is hurting the middle and lower classes while exacerbating income inequality as top income brackets benefitted from rising stock and home values.
While major averages keep making new highs, many former leaders have been crushed. Go-go growth stocks, SPAC’s, IPO’s, Cryptocurrencies, biotechs and NFT’s have come back down to earth, with many already experiencing 50% declines. This is a healthy change, but markets remain in transition.
Here is what we can expect as we enter 2022:
• Covid-induced supply chain improvements will come in fits and starts. Omicron is snarling emerging markets, particularly China. More factories are understaffed again. The U.S. has wisely changed Covid quarantine rules to fewer days. This endemic is not going away. We have to live with it and that means less time out of work after testing positive. The quicker factories overseas follow that lead, the quicker supply chains can improve.
• Geopolitical risks are coming to the fore. It has been relatively quiet on the international front, but there are many moving parts. Russia and Ukraine, China and Taiwan, Iran’s nuclear desires are all possible problems in 2022. Biden is sure to be tested.
• Auto production will ramp up. The auto sector alone contributed 1% to the CPI increase, with used car prices up 30%, and tires and other auto parts up 20%. Supplies are coming, and whether it is in 3 months or 12, inventory will improve. This sector alone can help the inflation narrative tremendously. Also, expect electric vehicle sales to soar next year. Hopefully, the infrastructure can handle all the necessary charging!
• The service industry will keep rebounding. Early last year it was thought vacationers would travel again. The Delta variant threw a wrench into those plans, pushing the recovery out even further. Now that quarantine rules are being relaxed, travel should gradually improve.
• Inflation will be top of mind and scrutinized at every level. No one can accurately calculate how much of 2021’s inflation stemmed from Delta shutting down factories, nor can they predict inflation once supply chains normalize. A lot of well-respected economists’ predictions are in the 2% – 4% range. The exact number may not matter much, as long as it is lower than the 6.8% registered in 20201. What is important is the trend.
• The Federal Reserve will raise rates prior to the election. Although not outwardly political, the Fed hardly wants to shake markets during an election cycle, but it must react to inflation.
• Unemployment will keep coming down, possibly breaking records. As consumers are forced to use their savings as Government handouts end, more people will come back to the workforce. This will help wage inflation. 2021’s wage increases are here to stay, and increases will probably continue, but at a slower pace.
• A slowly rising stock market, characterized with 2 steps forward and 1 step back, is normal. Major averages typically have three 5% drops and one 10% decline every year. Investors have been spoiled the past few years with easy money bolstering stock prices. Expect a return to normal.
• Market leadership can change. This has already happened the past few months as “story” stocks hit reality. Peloton, Zoom, StitchFix, Nio, DoorDash and even Moderna investors were taught a valuable lesson. One product can get you on the map, but a long-term game plan with real earnings growth is much more difficult to achieve. With Fed easing transitioning to Fed tightening, albeit in baby steps, investors should favor companies with high-quality free cash flow and predictable earnings streams. Don’t forget growth, but growth at a reasonable price, not ANY price.
It has been a tumultuous few years, albeit one where all investors grew their net worth. Our key going forward is to protect those gains while also playing for further upside in a more cautious manner. Earnings will be 10% – 15% higher next year. If the Fed can create a soft landing on inflation, the bull market can continue. Flush savings, plentiful jobs, ultra-low interest rates and record net worth will cushion a few rate hikes. However, stocks are priced for perfection, so caution is warranted. So long as earnings are growing and the yield curve is positively sloped, history says to stay the course but stick to your asset allocation.
Cheers to a happy and healthy 2022. Happy New Year everyone!
Olympic star, Gabby Douglas is 26 today. Donald Trump Jr. turns 44. Actors Anthony Hopkins, Ben Kingsley and Val Kilmer are now 84, 78 and 62 years young.
James Vogt, 610-260-2214