In order to look ahead, we must first take stock of where we’ve been. 2021 was a fairly volatile year for the economy. Depending on which polls you read, the public was often equally (or more) concerned with the economy than it was with the ongoing pandemic. Given many of the leading economic indicators, it’s easy to understand why.
Inflation has been a primary concern. In 2020, as a response to the near-total shutdown of our economy, the government flooded the economy with trillions of dollars. In a typical year, according to the Federal Reserve, the money in circulation grows by about 6%. In 2020, the money in circulation grew by about 30%. Meanwhile, supply chain issues, which persist today, meant that in-demand goods were hard to come by. The recipe for inflation is simply too many dollars chasing too few goods. We certainly had both in spades. As a result, inflation in 2021 ran about 7% - the highest in forty years, according to the Department of Labor.
For much of the year, the Federal Reserve insisted that the majority of the increase in inflation was “transitory”; a position with which we disagreed. While we think the inflation picture will improve in the years to come, we think it will be several years before we see the Fed’s target rate of 2%. Prepare for another year of increasing prices.
The employment landscape has been a hot topic in the past year, with what has been dubbed “the great resignation.” This revolves around the notion that there is an employment revolution and realignment, whereby workers are quitting their jobs en masse to pursue better opportunities, often involving working from home. According to ZipRecruiter nearly 60% of workers indicate they would like a job that allows them to work from home, but only 10% of jobs offer than option and that number is likely to shrink as we enter post-pandemic life. The office is not dead.
What is likely true is that many of those who quit their jobs may find themselves in the same or similar sector, as the reality of experience, education, and job availability force their hand. In other words, a person who has spent two decades in hospitality may find it difficult to find a dream job in a different sector, at least without additional training.
According to the Department of Labor, there are still 1.5 unfilled jobs for each unemployed individual, and we see the unemployment rate continuing to improve as the pandemic wanes, and many on the sidelines return to work.
Interest rates are beginning to rise, with mortgage rates at nine-month highs. If you’re someone who has not refinanced your mortgage, the days to take advantage of historically low rates may be numbered. Rising interest rates may also work to cool what is a very hot real estate market, as people have been taking advantage of bargain basement mortgages for the last two years.
The construction cost of housing is close enough to the retail cost that we don’t see a major bubble in residential real estate. In other words, while we think the market may slow due to rising mortgage rates, we don’t feel that housing will experience a sudden drop in value.
We believe the Fed will also increase rates in a bid to help rein in inflation. Rising interest rates will have a negative effect on many types of bonds you may be holding in your portfolio. Bonds are often considered “safer” than stocks, but in a rising interest rate environment many will actually lose value. Consider that you if you are trying to sell a bond that pays 2%, and the prevailing rate in the market is 4%, then you will have to discount the price of your bond in order to entice a buyer. It’s important to work with your CFP® to understand your exposure to this type of risk.
As for the stock markets, they performed in-line with our expectations published in this column a year ago. US markets outperformed foreign markets, and we see that trend continuing throughout 2022. The US has an extremely robust economy, and it has been much faster at opening and staying open than many other economies. Consider that Canada, Europe, and Asia have all tended toward stops and starts with their reopening.
While we think that many foreign emerging and developed markets have good long-term upside, partly because many are currently in a hole, we don’t expect 2022 to be their year, and are much more bullish on the outlook for the US markets.
We do think it is likely that we experience a correction of 10% or more at some point during the year, and view that as a sign of a healthy market, as investors take the opportunity to move funds between sectors. Remember, after 100% of pullbacks, the US markets have gone on to see new highs. While that’s not a guarantee, it’s a pretty good track record!
The political landscape in the US has affected the domestic markets, as Congress can’t seem to get out of its own way in passing legislation, taking the better part of 2021 to pass a bipartisan infrastructure bill. We don’t see that improving in the new year, as Congress remains mired fighting over the things it can’t get done, spending little time focusing on what may actually be achievable.
Given the current landscape, and Congress’ detachment from the public’s primary concerns (the economy and Covid), we see the lower house being taken by the Republicans in 2022, possibly by a wide margin. Democrats may even lose the senate. We already see Democrats lowering expectations for their results at the polls this year, which is never a promising sign.
Personal political proclivities notwithstanding, gridlock is good. At its most basic, it forces compromise -which we’ve seen little of- or nothing. From a purely economic standpoint, one is just as good as another because it means the rules are unlikely to change, and markets like certainty.
From a fundamental standpoint, we see the outlook for the US continuing to improve, and have only a few concerns we are monitoring, which may affect our view.
Omicron showed us all how quickly a new variant can emerge and proliferate. So far, this strain appears to be mild, however a more virulent strain could emerge, which would certainly cause a ripple.
We are also eyeing certain geopolitical factors, namely China and Russia. Both seem eager to test the resolve of the west by asserting themselves in their respective spheres of influence. We feel that, almost certainly, China is watching to see how the world reacts to saber rattling by the Russians in order to determine any future course of action. Action by either country could have a short-term impact on markets and are worth watching.
In summary, we see 2022 shaping up to be a good but volatile year for the markets. As always, our forecast contains forward-looking statements. In our view, however, there are far more tailwinds than headwinds, and you should work closely with your CFP® to monitor your financial plan and ensure that you are capitalizing on the opportunities as they present themselves.
Stephen Kyne, CFP is a Partner at Sterling Manor Financial, LLC in Saratoga Springs, and Rhinebeck.
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