Equity markets rallied to reach all-time highs in 2021. In the face of high inflation, new COVID variants, and supply chain issues, the economy and stock market collectively thrived. The job market improved (even with a labor shortage), the consumer remained strong and continued to spend, and corporate earnings were robust last year. When you include a Federal Reserve that remained accommodative and kept interest rates low, the result was a very strong and prosperous stock market.
Looking at 2022, we expect both new and continued challenges (i.e., pandemic, supply chain, inflation). However, we feel optimistic about global equities and the economy overall this year. Here are our key themes and thoughts as we enter the new year:
Last year served as a sobering reminder of the adaptability and unpredictability of the COVID-19 virus. Two pieces of GOOD news related to the pandemic are that: (1) the new, highly contagious Omicron variant appears to be more mild and the major vaccines appear to work against it in terms of reducing severe disease and hospitalization. Many experts believe that the combination of high transmissibility and more mild illness could actually help hasten the end of the pandemic (cross your fingers!), and (2) the economy has continued to be resilient and show growth even in the face of this new variant, particularly when looking at consumer spending habits. Looking at this year, assuming the preliminary data on Omicron holds up, we see the economy continuing to rebound and grow, particularly as we enter early Spring.
From higher used car and oil prices to higher lumber costs, inflation was the major economic story and issue impacting multiple facets of American life in 2021. US consumer prices increased at the fastest pace in nearly 40 years. “Transitory” may have been the main buzz word of 2021, which was used by the Federal Reserve to describe inflation as a likely short-term factor at the time. Of course, this belief did not come to fruition as inflation has persisted. We expect inflationary pressures to continue throughout most of 2022, but we do foresee a “cooling off” of these pressures throughout the year. Consumers should redirect spending from goods to services, which should help alleviate supply chain issues and bottlenecks. Wage inflation should continue but is also expected to cool off throughout the year as the labor supply increases. Overall, we expect inflation to subside to an extent this year but remain well above pre-pandemic levels.
Supply Chain Challenges
Supply chains were overwhelmed with the excessive demand for goods and services that we saw in 2021. We expect supply chain processes to be enhanced and inventories to be rebuilt. Together, this spending should sustain new orders, employment, manufacturing, trade, and ultimately, sales and earnings. As previously mentioned, we expect consumer spending to shift more towards services, barring any new COVID variants that may hamper travel and other related activities, which should further alleviate pressure on supply chains.
Valuations & Corporate Earnings
The valuation of S&P 500 stocks (as measured by the Forward Price-to-Earnings ratio) is currently 21x, which is over 20% higher than the 25-year average of nearly 17x. It is important to point out that most of this high valuation has been driven by GROWTH stocks (P/E ratio of 31x vs. the 25-year average of 19x), while Value stocks are much cheaper (16x) on a relative basis. It is also worth noting that while Large Cap stocks are currently overvalued, Small and Mid Cap stocks, particularly the Value components, are attractively valued compared to both their Large Cap counterparts and historical metrics.
These rich valuations of the S&P 500 do illustrate that US Large Cap stocks are expensive relative to historical measures. However, corporate earnings were impressive in 2021 to say the least, helping to legitimize these higher prices and valuations. S&P 500 companies have translated roughly 6% global economic growth and 15% sales growth into nearly 45% earnings growth and 70% Operating EPS growth last year. In 2022, we expect a less dramatic number as many are forecasting a 9-10% earnings growth rate in the S&P 500, which is still a solid number compared with past, pre-pandemic years.
Interest Rates & The Fed
The central bank has remained transparent about their plans to taper bond purchases. At their December meeting, Chairman Powell announced that they would accelerate tapering of its once $120 billion/month bond buying program, which should now end their historic asset purchases by March instead of the original June target. The March meeting is now presenting the first opportunity for the Fed to move on a rate hike. With that being said, even with the more hawkish tone, we believe the Fed will be measured in their actions with respect to raising rates or not. While Fed officials project as many as three rate hikes in 2022, we believe it is more probable that they will raise rates once or potentially twice this year.
The US added nearly 6.5 million jobs last year, averaging 537,000 jobs created per month, which equates to one of the best job markets on record. The unemployment rate ended the year at 3.9%, and wages surged nearly 5%. However, the US economy is still down over 3.5 million jobs compared to pre-pandemic levels. Nearly 1.5 million workers retired early during the pandemic, and nearly 2 million workers completely dropped out of the labor force entirely. With demand for goods and services heating up in 2021, the labor shortage made it extremely difficult for businesses to keep up and find workers. As COVID health and safety concerns hopefully subside in early 2022, the labor supply should increase, especially with higher wages as another incentive.
Strength of the US Consumer
Consumers remained financially healthy in 2021, and we expect the same if not more in 2022. Even as overall consumer sentiment was down, retail sales increased over 16% in 2021, while personal spending was up over 14%. Additionally, household net worth is at all-time highs and debt service payments are at all-time lows. Across the developed world, household savings are elevated. U.S. consumers saved almost $2.5 trillion more than the pre-pandemic trend. Home values are also up sharply. This is in stark contrast to the Great Recession when households endured falling home values and significantly lower equity prices. As mentioned previously, with the labor supply expected to increase and meet demand, and with higher wages expected, this should lead to another strong year for the consumer’s balance sheets and spending habits.
International Markets – Is this finally “the year”?
Once again, International stocks underperformed their US counterparts in 2021. While US Large Cap stocks returned over 20% in 2021, International Developed and Emerging Market stocks posted returns of 9% and -4.5%, respectively. Emerging Markets were most hampered by a slower COVID vaccination rate compared with developed countries, in addition to continued US-China tensions, which we expect to continue into 2022. Looking at 2022, valuations remain attractive in international markets, which bodes well for future performance of these markets, particularly developed countries, which are seeing higher vaccination rates that should support their economic recovery.
Bond yields remain low globally and returns were mostly negative across major bond indices last year, with the exception of Municipal Bonds, High Yield Bonds, and TIPS. TIPS were the best performer, largely driven by the sharp increase in inflation throughout last year. With rates likely to increase in 2022, this would continue to put price pressure on bonds, leading to likely lower performance once again. It is worth noting that US government bonds are still more attractive compared to their international counterparts, with the US 10-Year Treasury yielding 1.5% to end the year (now up to 1.8% to start the year) while most other foreign government bonds yielding near zero. Even with low yields and lower expected returns, bonds still play an important role in portfolios from a protection and diversification perspective, which means that fixed income remains a vital piece of building a diversified portfolio.
Potential New Tax Legislation
While President Biden’s social safety net bill hit a major road block at the end of the year, it is likely that a different version of the bill, or an entirely new bill, will be introduced at some point this year. Major tax hikes that could result from a potential new tax law could impact both individuals and corporations in significant ways, whether it be increasing marginal tax rates, capital gains rates, or removing certain deductions. It remains to be seen what any new tax legislation would look like at this point, but it is a potential headwind for markets and the economy that could show up at some point this year.
YCharts, Sanctuary Asset Management CIO Outlook 2022, Sanctuary Wealth Chartbook November 2022
Registered Representative of Sanctuary Securities Inc. and Investment Advisor Representative of Sanctuary Advisors, LLC. Securities offered through Sanctuary Securities, Inc., Member FINRA, SIPC. Advisory services offered through Sanctuary Advisors, LLC., a SEC Registered Investment Advisor. Tenet Wealth Partners is a DBA of Sanctuary Securities, Inc. and Sanctuary Advisors, LLC.
The information provided in this communication was sourced by Tenet Wealth Partners through public information and public channels and is in no way proprietary to Tenet Wealth Partners, nor is the information provided Tenet Wealth Partner’s position, recommendation or investment advice. This is for informational purposes only.