The first season of a great television series is often hard to top. The excitement of a new plot, meeting the major characters, and understanding the themes of the show means that every subsequent season will be compared to the first. Well, if 2020 was season one of the pandemic 2021 was the promising albeit repetitive second season. The stock market was great for investors in seasons one and two (more on that in a minute), but the cast of villains had some changeover.
In 2020, covid, pandemic induced unemployment, and recession were the major villains at play. As we look back at 2021, covid was still one of the overarching villains, but the threat of high unemployment was replaced with staffing shortages. Furthermore, the recession of 2020 seems like a very distant memory with a healthy economy and consumers contributing to product shortages and rising inflation.
As we turn the corner toward 2022, we see three major villains or threats toward market growth: The first is obviously Covid. It appears that the pandemic will be turning into an endemic and we will be living with the realities of this virus for a very long time. With that being said, it is certainly less of a threat than it was in 2020, as it was novel and nearly unprecedented. With the prevalence of vaccines, the medical community learning more about treating covid, and hopefully milder variants, we are optimistic that covid will not derail the market and economy again. However, if more dangerous variants emerge or hospitals become overrun with even milder variations such as omicron, governments could look to impose lockdowns again which would certainly be problematic for markets.
The second major threat is inflation. The Fed let inflation run too hot last year and they know it. We cannot know if they did this intentionally to spur economic growth or were misreading the data, but inflation is borderline out of control. Back in July, I wrote that inflation was a problem and the Fed was wrong to describe it as transitory. I’m definitely not more qualified on this topic than the very well educated members of the Federal Reserve but since that time they have announced that they are going to stop calling inflation transitory. They have also discussed actions to address inflation which leads to threat number three.
Rising interest rates and tapering (aka slowing money supply) are the two major tools the Fed can use to combat inflation, and they will likely implement both of these tools in 2022. The irony is that these tools are combating a threat (inflation) and presenting their own threat. For example, if the Fed raises interest rates too fast, it can cause a market shock and a major sell off. This happened in Q4 of 2018, and the S&P 500 lost nearly 20%. Alternatively, if the Fed does not act quickly enough, inflation will prevail which can lead to lower economic growth (aka stagflation). The Fed has a delicate balance it must achieve here and although they are qualified to do, so they do not always get it right.
Despite these challenges there are, of course, opportunities. If the Fed does raise interest rates, that will be difficult for bonds and growth stocks but good for value stocks and potentially international equities. Additionally, if the Fed does not raise interest rates, it most likely means one of two things: Either inflation has become manageable and growth stocks could continue their run, or inflation is still a problem and hedges such as TIPS and gold will be especially important.
No matter what happens in 2022, we can say that we do not expect the same level of results as you see below from 2021. The market in some areas performed exceptionally well and in others (emerging markets and international developed stocks) has left some room for growth.
As you can see, U.S. markets performed well across the board last year with the only weak spot being small growth companies. What does not show in this chart is that large growth companies have been on a nine month tear upwards while small value companies achieved nearly all of their 28% in growth during the first quarter of last year!
When we look at additional market indices it becomes clear just how dominant the U.S. stock market was last year. The bond market does not really compete with the stock market but merely works in tandem to provide a volatility hedge, so we should not be surprised that bonds underperformed in such a banner year for stocks. However, the performance of international and emerging markets indexes was quite disappointing. While this may be disappointing, we are not discouraged. U.S. equities look very expensive compared to international markets. We believe that there are great opportunities for the long term investors who stayed invested in those asset classes.
Thank you again for your business and your confidence. May blessing be bestowed upon you and your family in the new year!
This commentary on this website reflects the personal opinions, viewpoints, and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written by: Brice Carter