While we are often reluctant to provide specific “predictions” for market returns over a particular timeframe, we understand client’s desire to read them. The investment industry thrives on the practice of predicting the future, though we hardly ever look back to grade the accuracy of such fortune telling (hint: it is not particularly good). But human nature craves control and our belief in such outlooks helps give us, rightly or wrongly, some small semblance of comfort. At HCM, we believe that it is much easier to react to the present than predict the future. But today we will push that belief aside and try to provide some framework around what we think could take place over the next 12 months. Our purpose is not to provide exact numbers, but rather to provide general themes and how to best take advantage of those opportunities.
Last year provided a rare combination of returns for stocks and bonds. The chart below outlines the combined returns for both asset classes going back to 1977. As you will notice, most of the return combinations lie to the right of the vertical, center line denoting that both stock and bond returns were positive. 2021 represented a year where stock returns were positive, but bond returns were negative. This scenario could play out again in 2022 and according to Blackrock Investment Institute, it would be the only time in the past 50 years you had positive stock returns with negative bond returns in consecutive years.
What does this mean?
As we look to 2022, our base case does not look much different than it did in the beginning of 2021. Then, we focused on a reflation of the economy. The introduction of COVID vaccines, coupled with twin stimulus from both fiscal and monetary authorities would generate higher levels of economic growth and inflation. This environment would favor value, small cap and be punitive for low quality growth stocks and bonds.
While the details of *how* we get there may be changing, the destination will likely be very similar. The market’s ability to deal with COVID-related shocks has increased significantly over the past 12 months. That resolve is slowly building in the economy and provides a framework for growth, both on a macro and corporate level. As the supply chain continues to untangle, the hope is that inflation levels will moderate allowing the Fed to be more measured in its response. It has already begun to taper its asset purchase program. Our belief is that it is not eager to begin to raise interest rates. Slowing inflation and a muted central bank response should lead to a steepening of the yield curve and provide a positive backdrop for stocks. Specifically, asset classes that performed well in the first part of 2021(value and small cap) should lead the way again. As rates move higher, low-quality growth and bonds may suffer as the market begins to adjust to the end of unlimited policy accommodation from the Fed and other central banks around the world.
The two outlier scenarios to our base case described above would certainly lead to a change in portfolio allocations. The first would be if inflation continues to run higher than expected and the Fed is forced to act in a more aggressive manner. A forced increase in rates would certainly create problems for the economic recovery and lead to the combination of high inflation with little to no growth…otherwise known as stagflation. This scenario would be bad for both stocks and bonds.
The second alternate scenario involves some type of growth shock. This could be anything from an unknown COVID variant to a simple miscalculation of economic prospects. Any significant slowdown in growth would give the Fed room to reintroduce asset purchase programs. But, if those programs sputtered and economic growth did not take hold, stocks would fall as interest rates and earnings declined as recession fears rose.
HCM remains positioned for reflation, though we don’t expect to see the same level of strength we saw in the beginning of 2021. Our stock positions continue to favor value, small cap, quality, and large, high-quality growth. Bonds will remain a challenge in 2022, as low-income levels may not be enough to offset the threat of rising rates. We have already added alternative forms of fixed income to portfolios and will continue to look for solutions that offer an appropriate balance of income, safety and protection against rising rates.
Weekly Focus – Think About It
“Year’s end is neither an end nor a beginning but a going on, with all the wisdom that experience can instill in us.”
- Hal Borland
Performance last week for the four major asset classes were:
- U.S. Stocks – Russell 3000 (IWV) – Gain of 0.69%
- Developed Foreign Markets (EFA) – Gain of 0.42%
- Emerging Markets (EEM) – Gain of 0.32%
- Fixed Income (AGG) – Loss of -0.11%
(Note: performance is based on the change in price plus dividends)
Last Week’s Headlines
- Initial jobless claims totaled 205,000, sustaining a downward trend from the highs of the pandemic and moving the 4-week moving average to its lowest level in 52 years.
- New US Home sales jumped 12.4% to a seven-month high, buoyed by low mortgage rates and higher demand
- US durable goods orders rose by 2.5% in November, boosted by a sharp rise in aircraft orders.
Eye on the Week Ahead
- CPI and PPI readings will give investors a sense of where inflation is and how that might affect the Fed’s decision to raise rates
- Retail Sales will give a snapshot into the health of the consumer
If you have questions about the recent market conditions, please contact a member of HCM’s Wealth Advisory Team:
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- The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
- Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
- Past performance does not guarantee future results.
- You cannot invest directly in an index.
- Consult your financial professional before making any investment decisions.
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