2021 Fourth Quarter Outlook and Review
January 14, 2022
Dear Clients and Friends,
For a year that began with the storming of the US Capitol and a worsening supply chain crisis, then proceeded through a series of devastating natural disasters, and ended with soaring inflation and a dramatic surge in COVID cases, 2021 was remarkably generous to investors.
Despite a barrage of challenges, stock markets worldwide posted a third year of solid gains, reflecting a recovering global economy, increased consumer spending, and strong corporate earnings. Real estate, cryptocurrencies, and commodities also rose. Wage gains, government subsidies, and appreciating home prices and investment portfolios have left many people in their best financial shape for years. US economic output has now surpassed pre-COVID levels.
Bond markets, by contrast, posted modest losses, reflecting the growing certainty that central banks will hike interest rates to restrain growth and prevent inflation from getting out of hand. Whether or not this marks the end of the forty-year bull market for bonds remains to be seen.
Outlook
The outlook for 2022 appears mixed. On the one hand, a strong job market and unemployment that is trending towards record low levels will support continued economic momentum. The supply chain problems that have constrained global trade and led to higher prices should gradually resolve as manufacturers ramp up production and transportation blockages are sorted out.
Corporate earnings are expected to grow at a slower but still respectable pace in the coming year. Even with several increases in the Federal Funds rate, real interest rates will remain extremely low by historical standards.
Omicron appears to be milder than previous versions of COVID 19, and its extraordinarily rapid spread, combined with broadening vaccine programs, should bring us closer to the elusive goal of herd immunity.
On the other hand, the variant is already putting the brakes on service industries (restaurants, hospitality, and travel) and the early part of 2022 is likely to see a drop from last year’s heady economic growth rate.
Moreover, the future of fiscal stimulus is uncertain with the stalling of the Build Back Better bill and midterm elections that could shift the balance of power in Congress. The loss of the Child Tax Credit will particularly impact low and middle-income households.
The Fed and other central banks worldwide have signaled their intention to throttle inflation with higher interest rates, which could negatively impact both economic growth and the valuation of financial assets. And though inflation itself should begin to taper off, higher prices for food, rent, gasoline, healthcare, and other basic goods and services, are likely to persist for at least several months to come, putting pressure on consumers.
Stock and bond prices have been distorted by years of rock-bottom interest rates, and financial markets are vulnerable to disappointment at current levels, especially in an environment of monetary tightening and moderating growth.
Finally, geopolitical tensions in Ukraine and the South China Sea as well as political discord in the US will continue to fuel general uncertainty.
A best-case scenario would see a “soft landing” in global growth; a gradual rise in policy rates that leaves real interest rates at still-low levels; moderating inflation combined with continued strength in the jobs market, and the waning of the global pandemic. In such a climate, equities could generate positive, if less exuberant gains and bond markets could be modestly down. Relatively attractive valuations in foreign markets, small-cap, and value stocks point to investment opportunities that we are positioned to capture.
That being said, we would not be surprised if the above-listed concerns cause volatility to spike this year after an unusually calm 2021. Our balanced, diversified approach should enhance portfolio resiliency in the event that market conditions become more challenging.
We welcome your questions and wish you abundance, health, and peace in the New Year.
The LongView Team.