2022: Caution is in Order
Primarily due to the unprecedented amount of fiscal and monetary stimulus provided by the U.S. Government and the Federal Reserve, risk assets (stocks and real estate) appreciated nicely in 2021. The Dow Jones Industrial Average rose 19% and closed at its high for the year on December 31st. The bond market did not fare as well recording total return losses of 4% or more for the year. The November 22nd announcement by the Federal Reserve to move to a more restrictive monetary policy due to rising inflation concerns suggests that higher interest rates will continue to put downward pressure on bond prices in the New Year.
With 2021 in the rear-view mirror, what are the market prospects for 2022? Can U.S. Stocks avert a “sophomore slump”? Over the past 75 years, in the second year of a new U.S. president’s term, stocks have tended to fall short of their long-term average annual performance. Whether or not this bit of history is a good forecasting tool, there are reasons why the market’s performance this year may be far less impressive than it has been since the low reached in March 2020. Among the headwinds that the market faces are the expiration of government aid programs to offset the impact of Covid-19, rising interest rates, and supply-driven glitches that have caused shortages of goods and helped fan inflation. Here are the most likely headwinds for the stock market in 2022.
Strong economic growth effects from Covid relief programs are fading. Assuming no change in the rebirth of BBB (Build Back Better), the result will be a radical downshift in income growth for the entire country this year unlike the past 2 years.
Federal Reserve policy will not be as helpful for stocks. With inflation numbers “running hot”, the Fed has signaled its intention to reduce asset purchases and to raise interest rates several times this year. These steps would remove a large amount of liquidity from the financial system. A dramatic rise in bond yields would be harmful to equities especially considering their current “overvalued” status.
Corporate profit growth may lose steam. Rising wages, soaring freight costs and higher material prices will likely cause a slowing in profit growth which will call into question the sustainability of today’s high P/E ratios.
Uncertainty surrounding the Fall elections. Voters will decide whether or not to continue with the policies of substantial growth in government and the resultant expansion of debt and deficits or to reverse course and adopt a more restrained fiscal and monetary approach to the markets and governing policies. Markets will likely experience considerable volatility in advance of the voters’ decision.
Accordingly, Walls Investments will be initiating a more cautious approach to markets as we begin 2022. While we are hopeful that the financial markets can successfully overcome these challenges, a little bit of caution is the order of the day.
Happy and Healthy New Year to all!
