January 21, 2022
Valued Clients and Friends,
We hope you have enjoyed the New Year thus far. 2021 was a strong year for the economy and investors, and we remain optimistic as we look ahead.
The economy continued to rebound in 2021, with GDP growth likely exceeding 5%. Corporate earnings increased sharply, significantly exceeding expectations and helping stocks to perform well. Fiscal stimulus and accommodative Federal Reserve policy allowed the economy to maintain its footing over the uncertainty of the Delta and Omicron variants of COVID, but businesses and consumers look poised to stand on their own going forward. Now that the government spigots are beginning to shut, 2022 will be the year for the economy to prove the recovery has legs. Increased CAPEX spending by businesses and continued health from households should allow the baton to pass from government spending to that of US consumers and corporate America.
The consumer is in a healthy place, with $28T of household net worth generated since the end of 2019. Consumer balance sheets have been flush with cash, with middle-income households having accumulated 2 additional months worth of after-tax income in cash. The very health of the US consumer may be driving the two phenomena at the top of investors’ minds: “The Great Resignation” and inflation.
Job openings continue to remain high, with almost 11M available as of the end of 2021, 3.5 million more than the peak prior to COVID. There are many factors at work here – including COVID spurring early retirement for some of the older population, and healthy balance sheets leading some individuals to remove themselves temporarily from the workforce. As cash reserves begin to dwindle and stimulus begins to fade, however, we expect these job openings to be filled over time.
The supply chain disruption and increased consumer spending has driven significant inflation, reaching 7.0% CPI (Consumer Price Index) growth over 12 months as of December 2021. There has been a tremendous surge in demand for goods, well above pre-pandemic levels. Spending on goods increased 40% between October 2019 and October 2021 compared to just a 28% cumulative increase over the prior 11 years since the financial crisis. This helps explain unusual data points, such as how used cars, a very small component of the CPI basket (4.4%), has contributed 35% to the overall year-over-year increase in Core CPI. As supply chains are made more robust and demand for goods reverts to more normal levels, we expect inflation to come down from its current elevated levels but remain well above the recent historical 2% average.
The Federal Reserve (Fed) maintained its patience over 2021, keeping interest rates low to encourage increased spending in the economy. But as inflation figures spiked, the Fed began to change its tune and indicate a policy shift to combat rising prices. Interest rate hikes are likely coming in 2022, with the market currently pricing in four, beginning in March. This will be an important factor to watch; should the pace of hikes become excessive in the eyes of the market, stock valuations may be forced to reset lower. However, investors may deem them appropriate if economic growth appears sustainable and corporate earnings continue to exceed expectations. In the past 13 periods of rising rates, the S&P 500 has averaged annual returns of 12%.
Despite the current health of the economy, we expect more choppiness in markets than we’ve seen over 2021. Federal Reserve policy and mid-term elections will likely dominate the economic news headlines this year, which may lead to temporary displacements in stock valuations. Market corrections are often more severe during mid-term election years, averaging 19% versus 13% for all other years. We are positioning client portfolios to take advantage of any short-term buying opportunities that may arise.
Overall, however, most economic indicators continue to point towards a healthy economy on pace for above average growth as the recovery from the pandemic continues. We look forward to 2022 and the potential for investors that lies ahead. We wish each of you a healthy and prosperous new year, and as always, invite you to reach out should you have any questions regarding your portfolio.
Gallacher Capital Management Investment Committee