Happy New Year! We welcome the arrival of 2022 and are hopeful for the opportunities each new year brings.
2021 closed with a moderate “Santa Claus” rally amid continuing supply chain and inflation pressures. While equity markets faired well in 2021, fixed income markets struggled and failed to stay in the green. For most of you who have seen my “critically-acclaimed” drawings, you may remember my picture of a teeter-totter with prices of bonds on one side and interest rates on the other. As equities took off last year, fixed income became less appealing as often happens during a recovery. To add to this, late last year the Federal Reserve changed its policy with the aim of increasing interest rates sooner than expected. These two developments helped push bond prices lower and interest rates higher. Although quality fixed income experienced negative returns in 2021, the changes to our portfolio helped protect against this trend. While fixed income generally helps control volatility and provides insurance against economic downturns, it can often be challenged during this part of the cycle.
Looking to our forecasting models, we see the economy shifting gears from accelerating growth to decelerating growth. To the extent allowed by government actions around Covid, the underlying economics are normalizing. Despite year-over-year growth slowing, the data indicates economic growth will remain above average through 2022. Assuming the Federal Reserve doesn’t act too aggressively in the coming months, we don’t anticipate a recession this year or next. While inflation hit its highest level in 30+ years, we believe the combination of monetary tightening and supply chain resolutions will bring it down to a more normal level. However, rising wages will likely be a sore spot as there doesn’t seem to be a solution to the labor shortage in the near-term. As for equity markets, we do not expect to enter a bear market, nor do we expect to repeat a meteoric rise in prices. We do expect more volatility as equity markets digest slowing growth and a Federal Reserve now signaling that it will attack inflation more aggressively. Technology and growth-oriented stocks which have reached substantial valuations could be more susceptible to these trends, whereas financials and energy names should fare more favorably. On the fixed-income side, upward pressure on interest rates will continue which leads us to keep our hedging positions in place for now. As I have mentioned before, fixed-income investing is a full business cycle endeavor. When interest rates were falling we took advantage of that trend. Now that rates are rising, we look to protect valuations. The latter phase is what we are currently experiencing. In summary, we continue to look for companies with positive earnings trends, moats against competition, and management that is nimble in making adjustments. We look forward to a prosperous new year. As always, please feel free to contact us if you have any questions and we thank you for your trust!
Marc Henn, CFP®