Despite challenges, including an unexpected resurgence of COVID, the return of inflation, and disruptive supply chain issues, the U.S. economy and markets faired surprisingly well during 2021.
In fact, recent economic indicators suggest significant momentum in the economy. Consumer spending has been booming, employment is strong, and housing starts are on the increase. At the same time, we have been in a historically low interest rate environment, which can make capital for expansion easier to come by.
For the first time in many years, inflation spiked and emerged as an area of concern. Despite the current high rate, the main driver of the inflation we are experiencing is a booming economy. The Federal Reserve is expected to take measures to help control inflation by tightening monetary policy (raising interest rates) assertively in the coming months.
Corporate earnings and earnings projections have been strong, driving U.S. markets to soar for a third year in a row. During 2021 markets were briefly disrupted by emergence of the Omicron virus, but the impact came and went quickly. Investors seem to have voted that this surge won’t materially impact the economy.
Once again, what investors experienced during 2021 illustrated the folly of trying to predict the future of markets. As the year started, media chatter suggested that markets were in a bubble, price to earnings ratios were a red flag, and corporate earnings growth could not be sustained. Yet the S&P 500 returned 26.89% for the year.
Markets are “predictably unpredictable”. What you can reasonably expect is that markets will shift up and down in the short run (often dramatically) and rise in the long run. A disciplined investment strategy, integrated with your financial planning, can help you weather the short-term ups and downs of the markets and achieve your most important goals.
Today’s Economic Perspective
The U.S. economy, as measured by the GDP, rapidly declined back in the second quarter of 2020. Since then, the GDP has largely recovered its former trajectory. The unemployment rate is moving steadily down toward the record lows that the economy had reached before Covid reared its ugly head.
The index of leading economic indicators rose sharply in November, suggesting current economic expansion has some life left. However, inflation, continual supply chain disruptions, as well as the resurgence in COVID pose risks to GDP growth in 2022.
The spike in Inflation over the last 12 months is at levels not seen since the old “stagflation” days of the 1980s. As the Federal Reserve takes initiatives to control inflation, interest rates are likely to rise. This can make access to capital more challenging and slow economic growth.
Some economists argue that it takes an economic recession to trigger a bear market (defined as a prolonged price decline of > 20% among widespread pessimism and investor sentiment). So far, the economic data does not signal a recession is on the immediate horizon.
Today’s Market Perspective
By all accounts, we are in an extraordinary period of investment history. The markets, as measured by the S&P 500 index, have now doubled since New Year’s 2018, and it is hard to find three years to match the three-year record of 28.88% (2019), 16.26% (2020) and 26.89% (2021) returns that some index investors have enjoyed during this remarkable stretch. With interest rates and bond yields at rock bottom, investors seem to have decided that stocks are the only way to make money in their investment portfolios.
A key question is whether companies will be able to maintain their rising profit margin trajectory with the shortage of workers and the resulting higher salaries throughout the economy. Labor costs rose a remarkable 9.6% in the third quarter of 2021, and productivity (which is a function of the cost of labor) dropped 5.2%. In manufacturing, unit labor costs were up 4.6% and productivity decreased 1.8%.
Following the extraordinary market returns of the last three years, no one should be surprised to experience more modest returns in stocks for a while, even if the economy continues to thrive.
Volatility and periodic market corrections can also be anticipated along the way (a market correction as defined by a decline of 10% or greater that lasts days, months, or even longer). Taking a long-term view of your investments can go a long way toward weathering corrections without much trepidation.
Final Thoughts
The signs are mixed going into 2022, but when has it been otherwise? If there’s one lesson to take from this long, extended period of market prosperity, it is that the future is unknown, and the surprises more often favor the upside than the downside.
The markets will certainly pull back at some point, but that prediction has been made for each of the years that have contributed to the recent 100% growth in stock values. A steady course has been surprisingly beneficial to investors. A disciplined, long-term approach, focused on your goals has always been a winning investment strategy.
As always, we are committed to providing you objectivity and steady guidance through both volatile markets and euphoric markets – to help you recognize and act on the opportunities that can benefit you financially. Our goal is to help you achieve peace of mind to enjoy your life and focus on what really matters most to you.
