In spite of the worldwide economic shutdown caused by the COVID-19 pandemic, the last two years have been exceptional for US equity markets! Once the economy reopened in 2020, equity returns were strong, and market volatility was exceptionally low. Today corporate earnings are at record highs. We expect earnings to continue to grow in 2022, albeit at a slower pace. Our outlook assumes equity returns will remain positive but moderate, as the Federal Reserve begins to raise interest rates.
How do we get there?
Keep in mind that although we maintain a bullish outlook for 2022, markets are way overdue for a correction. Since the March 2020 lows, the S&P500 advanced 119% from trough to peak without any meaningful correction. This is highly unusual. As we discussed with many of you last year, a 10% to 15% correction is still likely to occur at some point in the near future. Despite a possible correction, we still expect positive equity returns in 2022.
Headwinds
Inflationary pressures have grown, interest rates are rising, and fiscal and monetary support are waning.
Inflation, as measured by the Consumer Price Index (CPI), is currently running at a 6.8% pace, significantly higher than the Federal Reserve’s 2% target. This is the highest inflation reading since June of 1982. Congress and the Fed fueled inflationary pressures by passing over $5 trillion in fiscal stimulus and lowering interest rates to 0%, to cushion the effects of the pandemic. Both measures were extremely beneficial to the US economy.
In 2022, markets expect the Fed to begin raising interest rates to combat inflation. History suggests that when interest rates rise, all asset classes (i.e., stocks and bonds) fall. However, stocks typically rebound as companies pass through price increases to consumers. Since companies can pass through price increases, corporate profits and margins are expected to remain healthy.
Haven Wealth Group Strategy
On a relative basis, we believe stocks are poised to outperform bonds in 2022. Interest rates remain at historic lows, while yields on dividend-paying stocks are significantly higher than interest rates on bonds. Over the past 20 years, growth stocks have outperformed value stocks. However, when the Fed raises interest rates, growth stocks experience greater volatility as compared to value stocks. To reduce portfolio volatility, we are adopting a more defensive approach to equity selection in 2022.
In summary, markets are expected to become more volatile in 2022, as the Federal Reserve begins raising interest rates. Keep in mind that the Fed is raising rates because US economic growth is strong, and the US economy is also approaching full employment.
If you have questions or concerns, feel free to give us a call. We would be happy to discuss our economic outlook.
Wishing you and your loved ones a Happy New Year!