By Rick Schwerd
The end of the year is always a good time to take stock of your investments and look ahead. Last year at this time, it was easy to be bullish on the stock market. Vaccine distribution was just starting, the country was continuing to reopen and unprecedented stimulus was being injected into the economy.
As we head into 2022, there is still a lot to be positive about, such as robust company earnings and a very healthy consumer base. However, concerns about the Omicron variant, global supply chain issues, labor shortages and inflation are tempering enthusiasm.
Stock markets had another good year. The Standard and Poor’s (S&P) 500, an index of 500 of the largest companies in the U.S., is up approximately 20 percent year-to-date, as of early December. Small-cap stocks, mid-cap stocks and most international markets have also shown strong gains this year. As expected, short-term interest rates have remained near zero as the Federal Reserve continues its accommodative fiscal policy. Intermediate and long-term rates have risen as the economy has improved, but in a measured way.
As we look forward, there is plenty to be positive about. The U.S. consumer is doing very well, which is vital since consumer spending accounts for nearly 70 percent of our Gross Domestic Product (GDP). The unemployment rate has fallen from 6.7 percent at the start of the year to 4.2 percent in November. Wages and salaries are up approximately 10 percent year-over-year. U.S. consumers have accumulated more than $2 trillion in excess savings and consumer net worth has surged about 30 percent since the start of the pandemic. These factors provide confidence that strong retail sales of goods and services will continue into 2022.
Supply chain issues have tempered growth this year. GDP started off the year strong, averaging 6.5 percent during the first half of the year. However, primarily due to supply chain issues, growth fell to a disappointing 2 percent in the third quarter. Microchip shortages, surging commodity prices and shipping container backups all contributed to slower growth during the summer. While it may take well into next year and likely longer to resolve all of the supply chain issues, it appears the worst of the effects may be behind us.
A healthy consumer and pent-up demand provides a bullish case for stocks as we move into 2022. Companies are not only able to increase sales, but also raise prices. This is allowing them to pass along their own higher input costs and continue to increase their earnings. Company earnings are the biggest factor in contributing to higher stock prices.
A highly accommodative Federal Reserve, strong demand and limited supply do have a dark side — inflation. After being dormant for years, high inflation reared its ugly head this year. The October Consumer Price Index (CPI) hit 6.2 percent, a level not seen in decades. Other inflation indicators also hit multi-decade highs.
The Federal Reserve, in justifying its stance, stated that they expect inflation to run above normal as we recover from the pandemic. They believed higher inflation would be transitory and would return to more normal levels in the near future. However, inflation readings continue to rise and are running well above the Fed’s elevated expectations, especially when it comes to wages and rents.
It is possible that as supply chain issues are addressed, inflation will level off and begin to normalize. However, if inflation continues to surge, the Federal Reserve may need to take a more restrictive stance. It may need to end its asset purchase program early, and begin to raise interest rates sooner and more aggressively than it previously indicated.
Periods of aggressive Fed tightening have resulted in volatility and negative stock returns in the past. Inflation and how the Fed navigates returning to a normalized fiscal policy will be key factors in market returns next year.
Investing in a properly diversified portfolio remains the best way to beat inflation and grow your savings over time.