The year 2021 saw a significant rebound in economic growth propelling real GDP above
its pre-pandemic level. Equity markets followed along, making new highs throughout the
year as corporate earnings continued their recovery. While the final numbers aren’t in yet,
the expectation is that U.S. GDP grew at roughly 5.6%1 in 2021 and will likely carry that
momentum into the first half of 2022 before slowing down later in the year. Not surprisingly,
the primary driver of economic growth was the U.S. consumer who unleashed a wave of
spending fueled by government stimulus payments, increased savings rates, and pent-up
demand following 2020’s lockdowns.
Aiding the recovery was a significant uptick in labor demand. Businesses rehired workers
and added new jobs to meet increased demand, bringing the unemployment rate from 6.7%
at the start of the year down to roughly 4.2% by year-end. As a sign of the ongoing labor
market’s strength, most recent data showed more than 11 million unfilled job openings,2
an all time record. This strength has led to meaningful wage increases as businesses
competed for workers to fill positions.
The flip side of this unprecedented recovery has been one of the most substantial increases
in inflation that we’ve seen in decades. Unsurprisingly, when significantly elevated cash
levels from government stimulus payments and Federal Reserve balance sheet expansion
met a wave of demand that couldn’t be filled due to supply chain issues, prices rose. As
it stands, the U.S. Consumer Price Index ended November at 6.9% (annualized) and has
been far more robust, in both its level and duration, than the Fed anticipated. By year-end,
this prompted the Fed to begin a more aggressive tapering of its bond purchase program,
which it will now likely wind down by March. This sets up the potential for a Fed Funds
rate increase by spring, with others later in the year.
|
S&P 500 |
28.71% |
Russell 1000 Growth |
27.60% |
Russell 1000 Value |
25.16% |
Russell 2000 Value |
28.27% |
Dow Jones US Real Estate |
38.99% |
MSCI EAFE (net) |
11.26% |
MSCI EMERGING MARKETS (net) |
-2.54% |
Bloomberg US Aggregate Bond |
-1.54% |
Bloomberg Municipal Bond |
1.52% |
Bloomberg High Yield Bond |
5.28% |
Source: Zephyr/Informa Investment Solutions |
U.S. equities had another outstanding year, with the S&P 500 up 28.7%
on back of strong earnings growth. Both revenues and profits continually
exceeded expectations over the course of the year as companies fought
to keep up with consumer demand. By year-end, even with the sharp
increase in the S&P level (price), overall valuations had moderated, with
the forward price-to-earnings ratio falling from 22.4x to 21.4x.3 While still
well above historical averages, this level continues to be supported by low
interest rates, a strong consumer, and increased government spending.
The question moving into 2022 is whether the likely increase in rates,
along with moderating GDP growth, unsettles equity investors.
The rising tide lifted all boats, and equities fared well across the style
and market capitalization spectrum with most U.S. asset classes up over
20%. Generally, small cap stocks lagged large caps, but small cap value
stocks did very well with the Russell 2000 Value Index up over 28%. Also
of note, real estate did exceptionally well, returning over 39% as measured
by the Dow Jones U.S. Real Estate Index as the asset class
continued its recovery and investors sought yield and
potential inflation hedges.
Internationally, developed market equities fared well but
lagged U.S. returns with the MSCI EAFE Net Index up 11.2%.
Conversely, emerging markets struggled on weakness in
China, and the MSCI Emerging Market Net Index was down
2.6% for the year.
Fixed income returns, outside of high yield credit, were
generally negative for the year as prices dropped with rising
rates. Yields, which continue to be extremely low, were
not enough to offset the weakness in prices, leading the
Bloomberg U.S. Aggregate Bond Index to post a -1.5% return
for the year. For bond investors, the only areas of the market
that provided meaningful returns were in high yield (below
investment grade) and inflation protected securities (TIPS).
The fixed income outlook for next year doesn’t look much
better, as the Fed will likely begin raising rates to combat
inflation. This will lead to more weakness in bond prices as
the yield curve adjusts to higher rates. For the near-term,
bond investors will need to focus on the diversification
benefits of owning fixed income, understanding their role in
dampening volatility in portfolios that own equities.
CPI: Consumer Price Index, PCE: Personal Consumption Expenditures
Source: Northern Trust, information as of 10/31/21
Inflation would seem to be the lynchpin in 2022. Is it short-lived
and likely to fade as we go through the year, or does it
become embedded in the economy? Right now, the camps
seem split, with arguments being made to support either
argument. But one thing is almost certain: Its trajectory will
play a significant role in how 2022 unfolds from a market and
economic perspective.
Asset prices have been buoyed by easy monetary policy for
over a decade, and if the punch bowl is removed by a Fed
that is forced to be more aggressive with rates, then equity
markets may bear the brunt of investor angst. Either way,
given current U.S. equity valuations, it’s likely that returns
moderate over the next few years as they take a breather
from their recent pace.
Of course, the virus will also play a substantial part in 2022.
Covid-19 has taken a horrible toll on us as a country, with
over 800,000 people having died from the disease and its
complications. Yet many have decided to return to a more
normal lifestyle, and there is little appetite for additional
restrictions on schools and businesses. At the same time,
hospital systems and workers can only endure so much,
and the government will need to do what it can to protect
them and their ability to function and provide vital services.
Any restrictions, whether in the U.S. or internationally,
could limit economic growth through lost revenues and the
exacerbation of supply chain issues. Equity markets will
continue to factor in the virus news flow as they attempt
to ascertain the likely winners and losers, and the Fed will
also need to weigh its policy decisions carefully in a very
uncertain environment.
Our expectation is that the global economic recovery will
continue in 2022 with GDP growth and inflation beginning
to moderate toward more normal levels as we go through
the second half of the year. Challenges will be posed by
the uncertain path of the virus, and the Fed will have its
hands full balancing the desire to fight inflation while not
undermining asset prices, but for long-term investors the
path ahead remains the same. A diversified portfolio of
equities, with allocations across various capitalizations,
styles, and geographic regions, remains the best way to
grow wealth over the long-term, and while bonds may be
handicapped in the short-term, they still provide stability in
difficult periods.
At CNB, our investment committee will continue to actively
discuss all of these factors and make adjustments in light of
new opportunities or to help mitigate risks based on market
conditions. As always, CNB Wealth Management is here
to help keep your financial plan on track to meet your life
goals. Please contact your advisor if you have any questions
or concerns, and we wish you and your family all the best in
the New Year.
Data as of 12/31/2021. Sources: 1The Conference Board December forecast, 2Bureau of Labor Statistics JOLTS report, and 3FactSet as of 12/31/21.
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