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Wealth Matters Newsletter - January 2022
Thoughts for a New YearWritten by: Mark P. Bernier, CFA, Senior Vice President/Wealth Management Officer
Equity markets delivered again in 2021 despite numerous headwinds that could have derailed the strong performances during the year. The S&P 500 led major domestic indexes, notching a 26.89% return, while the Dow Jones Industrial Average, the NASDAQ Composite, and Russell 2000 saw returns of 18.73%, 21.39%, and 13.70%, respectively (excluding dividends). International equity markets saw mixed results, with the MSCI EAFE and MSCI Emerging Markets indexes finishing the year with 8.78% and -4.59% returns, respectively (excluding dividends). Continued supply chain disruptions, labor market shortages, decades-high levels of inflation, new COVID-19 variants, and a U.S. Federal Reserve policy shift only temporarily gave investors pause throughout the year. U.S. bond markets exhibited mixed results, as yields continued to recover from the lows of 2020 and investors began pricing in interest rate hikes anticipated in 2022. As of this writing, the headwinds from 2021 remain unresolved and may not be for some time; here are themes we are watching for the new year.
It’s hard to believe that we are heading into the third year of the pandemic. While there is still much to be learned about the new highly transmissible omicron variant, it is certain that there will be economic impact from this highly transmissible iteration. Airlines have cancelled thousands of flights due to infection-driven shortages of flight crews, several major financial services firms have instructed staff to work from home until mid-to-late January, and hospitals across the nation are facing staffing shortages and capacity issues. These examples are just a few that illustrate the issues caused by this most recent surge. Numerous medical experts are predicting that the current surge in cases will peak in the coming weeks, and though early data on the omicron variant appears to indicate a less severe symptom presentation (particularly in the vaccinated population), we cannot predict the extent of the economic impact. The best-case scenario would be a decline in cases, and hospitalizations, as rapidly as both are anticipated to increase. A short-term spike would likely reduce any long-term or medium-term economic damage. As of this writing, markets are behaving as though this most recent wave and its economic impact fit the short-term narrative.
Simply put, inflation is the result of too many dollars chasing too few goods or services. Consumers rapidly added to cash savings in 2020 and 2021, as economic shutdowns and economic stimulus payments contributed to the largest surge in the savings rate in the U.S. since that data point has been measured. Not able to enjoy services as readily as before the onset of the pandemic, such as restaurants and travel, consumers embarked on a massive goods consumption spree (including real estate). The combination of increased demand, less inventory due to supply chain disruptions, relatively high levels available cash, and low interest rates drove inflation (as measured by the Consumer Price Index) to 6.8% in November (the most recent data as of this writing). This was the largest year-over-year increase since June 1982, according to the Bureau of Labor Statistics release on December 10, 2021. Through much of the last year, the Federal Reserve was characterizing inflation as transitory or temporary, but even they have recognized that inflationary conditions have lingered much longer than previously anticipated. As painful as the price increases have felt for most, there may be relief ahead. Much of the inflationary effects have been driven by supply-chain bottlenecks and exacerbated by Federal stimulus, in our opinion. Recent data have begun to reflect easing of those pressures, including shrinking backlog and supplier delivery times noted in the December Chicago Purchasing Managers Index figures. Federal stimulus, in the forms of direct payments to taxpayers or accommodative monetary policy, has ceased or are in the process of being wound down. While supply chain issues will not be resolved overnight, and omicron impacts notwithstanding, we anticipate inflationary pressures easing later in the year.
Stock Market Leadership
For the second time in ten years, the tech-heavy NASDAQ Composite index underperformed the S&P 500. As was commented on extensively in several of our newsletters last year, high valuation stocks were vulnerable last year and we anticipate a similar environment for 2022 for a couple of primary reasons: 1) we anticipate interest rates rising in 2022, which puts additional pressure on high valuation stock prices and, 2) as investors rebalance portfolios after two very strong years of returns, value-style investments will likely be the recipient of additional investment due to their relative value versus growth-style investments. See the charts below from JP Morgan Asset Management.
The chart above indicates that value-style investments are presenting more value (and therefore potential opportunity) to investors than any period since the bursting the dot.com bubble in early 2000. While we anticipate another year of positive returns for domestic stock markets, the returns are likely to be much more muted, perhaps in mid-to-high single digits. Aside from the unknowns surrounding the impacts from the pandemic, we also anticipate bouts of heightened volatility stemming from mid-term elections.
An old adage on Wall Street is that markets climb a wall of worry. Certainly, the past two years have offered support of the axiom and there are several worries facing investors and markets in 2022 that could provide a bit more height to that wall – pandemic uncertainties, Federal Reserve policy missteps, geopolitical tensions, and mid-term elections to name a few. We remain optimistic for positive outcomes in the new year, but our expectations are tempered by recent performance.
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