By Morgan Christen
CFA, CFP, CDFA, CEO and CIO
Mr. Blutarsky… zero point zero. After placing them on “double-secret probation,” Dean Wormer in Animal House finally put the nail in the coffin for the Delta House at Faber College.
2021 was the year we were “supposed” to have put the nail in Delta, or at least suppressed Covid. But alas, in came the “other” Greek letters.
Enter omicron. For anyone in the Greek system in college, you know there are nine more letters after omicron. Don’t be surprised to hear about pi, rho, sigma or tau in 2022.
Hopefully we get to omega (the ultimate limit) as soon as possible. We are living in precedented times.
Covid kept us from returning to normal, but the economy did bounce back.
The Biden administration continued to prop up the economy with unemployment benefits, halts on student loan debt and homeowner/tenant evictions, and of course… stimmy (stimulus).
The Fed continued to keep interest rates near zero and resumed bond buying. Supply chains were stressed, we were short chicken wings, diapers, computer chips, cream cheese (ransomware) and cars.
Although there were shortages, consumers were out buying, pushing up prices and fueling inflation. In fact, in November the Consumer Price Index rose 6.8% which was the largest print since 1982.
With stimmy, boredom and time, investors pushed up meme stocks, NFTs and crypto currencies. Remember PSINet stadium or CMGI Field? Much like the tech boom back in the 2000’s, stadiums are being renamed by companies in the latest craze.
The Staples Center is now Crypto.com Arena. Oh, PSINet Stadium is now M&T Bank Stadium (Baltimore Ravens) and CMGI Field is now Gillette Stadium (New England Patriots). Not predicting the end of Crypto, but there will be consolidation.
2021 reversed course for the stay-at-home and work-from-home stocks. Investors bet that Covid was dead and went long the “open-up” trade. Peloton and Zoom were among 2021s worst performers.
Overall, markets delivered a strong year for investors as U.S. corporations pulled in more profits in the three months ending September than ever before (Bloomberg). Markets had challenges on their upward path as inflation spiked, and supply chains disrupted global trade.
Low rates allowed borrowing costs to stay low and stock valuations to stay high. Valuations surged as Apple approached $3 trillion in market cap, while Microsoft was at $2.5 trillion, and Google hit roughly $2 trillion.
Meanwhile, Amazon’s revenue ranks them higher in GDP than several countries. U.S. equities bested their foreign counterparts, with small value stocks taking the top spot. Overall, larger companies performed well as the technology stocks in the large growth sector outperformed.
Inflation is here, but will it hold? Certainly, wage inflation will be here to stay, which has implications across the economy. Inflation also showed in the value of assets. As an example, the appraiser Miller Samuels reported at least 40 private homes in the U.S. have sold for more than $50 million in 2021. That is a new record.
The inflationary concerns forced a change in tune at the Fed. No longer do they believe inflation will be transitory and they will likely raise rates two to three times this year. Powell has made it clear that the Fed “won’t surprise.”
As the Treasury chart shows, there was a subtle shift in rates from the prior quarter, but a more pronounced move from the end of 2020. The anticipation for higher Fed funds rates pushed yields up on the short end of the curve, while flattening out beyond seven years.
There are many reasons the market could continue its upward march.
Let’s start with what could go wrong.
As we look out at the first few weeks of January, the rise in omicron cases could slow the economy as hospitals could get overwhelmed, new restrictions could be imposed and businesses along with consumers could delay purchases.
We are seeing a rise in inflation along with the worry that central banks will over-react. Finally, will the economy sputter and corporate earnings decline?
Covid will be around for a while and we will learn to live with it. The rapid spread of omicron could work in our favor as it should peak rather early and could help herd immunity.
2021 saw the ending of lockdowns and a robust economic recovery that lead to increased demand for consumer goods while supply chains were slow to re-start.
Add in all the cash infusions from the Fed and it is no surprise we have inflation.
As the chart above shows, the main jump in inflation has been from oil. As the Fed looks to taper bond buying, we are reminded of the 2013 taper tantrum. After comments from then-Fed Chief Bernanke in May, stocks initially fell, but the market was up 17.5% for the year. Most see the increase in rates as a “net positive” as it is a sign the central bank is comfortable with the US economy.
The future does not look that inflationary as the Census Bureau released estimates that show the U.S. population only growing by 0.1% (only 392,665 people) between July 1, 2020 and July 1, 2021.
That is the lowest rate since our nations founding.
Real GDP surpassed the pre-pandemic level in 2021 and should build on that. Earnings growth should slow into 2022 but should be generally positive. Corporations appear to have strong balance sheets, strong earnings, and cash.
Wall Street consensus is for real GDP to grow at +3.9% in 2022, with the number being front-loaded. Estimates are of +4.2% in the first half, followed by +2.9% in the second.
Assuming the Fed does not deviate from their plan or a more deadly form of Covid does not emerge, we believe the market should keep its toga on and party into 2022. We do not anticipate the returns of the prior year and we are adjusting your portfolios to accommodate higher inflation, interest rates and a move away from growth.
With the potential for higher interest rates, we are continuing to reduce our bond maturities, and adding inflation-adjusted bonds. You will also see some alternative and arbitrage funds that will further diversify your portfolio.
As the chart below shows, there are always reasons to sell. As Carlos Slim once said, “anyone who is not investing now is missing a tremendous opportunity.”
We look forward to speaking with and/or seeing you in 2022. We hope this will be a great year for you and your family. Please let us know if you have any questions as we move into 2022.
The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities mentioned. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.