We can’t always completely predict how the economy will look over the next year, but by keeping our eye on the trends and potential outcomes, we can be better investors.
Here is what our portfolio strategists and investment analysts are seeing in the economy and what they would recommend for investors in the coming months and years.
A Summary of the Economic Environment in 2021
To better understand what this year holds, it’s essential to understand what we have seen over the last year. In 2021 we saw a continuation of the solid economic recovery from the effects of the pandemic. Much of this recovery was aided by the Federal Reserve through asset purchases. Over the last several years, the Federal Reserve has helped financial markets and the real economy by buying mortgage bonds, mortgage securities, and other financial assets to “create money.”
The Federal Reserve had 4 trillion dollars on its balance sheet at the end of 2019. By May of 2020, they had increased this number to 7 trillion dollars, of which they kept ongoing maintenance through 2021. At its peak, this number reached roughly 8.8 billion dollars.
The stock market was up 35% in 2021, and earnings were up 40%. Overall, 2021 showed many signs of economic recovery, with only two significant areas of concern: inflation and supply chain issues. One well-known example of these supply chain issues’ impact is the demand for used cars and the incredibly high cost for these vehicles.
What We Saw in 2021 That Will Continue In 2022
One of the biggest economic factors that we expect to impact 2022 is the fear of rising inflation.
This year started with a high level of volatility as the Federal Reserve released their minutes from their most recent meeting. In the minutes they mentioned discussions around expected topics such as rising rates, but the one unexpected declaration was that the Fed was going to begin reducing their balance sheet — declining the 7 trillion they were feeding into the economy.
Why does this matter? For starters, the Fed’s balance sheet correlates strongly with the S&P 500. Everything is still indicating that the economy will be strong over the next year, but the rising rates are bad for the stock market because it’s bad for the bond market.
The bond market affects the stock market because of the assumption TINA, “there is no alternative.” Stocks are expensive based on their price-to-earnings ratio and are much higher now than historically. Bond rates are currently very low, and stock value increases when interest rates are low. If interest rates and earnings per year go up, the price-to-earnings ratio decreases.
Since most investors’ portfolios balance roughly 60% stock and 40% bonds, your returns may be different in 2022 than in years past.
How the Economic Environment Might Change in 2022
We expect to see individuals start to care about stock market valuations more than they have in the past, especially as the Fed begins decreasing their asset purchases.
Value stocks are widely inexpensive compared to growth stocks. We expect that small-cap, value, and international stocks will cost much less than US large-cap stocks over the next several years.
The biggest driver of return is the price you pay for the stock. Higher priced large-cap stocks would see a faster growth rate, and value stocks would show a much smaller, but steady increase. Over the last decade or so, this hasn’t had as much impact.
Now, investors will have to pay more for the growth, but that higher multiple means everything has to go right for the stock to continue making money. It’s a higher risk without a guaranteed return.
Take a large, fast-growing technology company that was an early entrant into many markets (i.e., Meta, Apple, Alphabet). In years past, they have seen fast and valuable growth as they were the first to offer new, innovative products or services. Now, the market is saturated, and the “next big thing” might not have as much potential for widespread success. While they still have the potential for positive returns, one wrong move could result in a fast and significant drop in value.
Inflation and the Labor Market
As we mentioned earlier, inflation will be the most critical factor to watch. Year over year inflation data is the key. We don’t expect 2022 vs. 2021 data to be anywhere near 2021 vs. 2020. As far as expected, inflation should begin to level off or slow down in the coming months. If it doesn’t slow down, that will be an area to pay close attention to as we make financial and investment decisions.
Both the unemployment rate and employment participation ratio have been low. We have seen challenges getting people to work and paying them higher wages.
Labor is the highest overall cost for business, so if labor costs increase, profit margins decrease. Margins are at an all-time high, but the perception is that these margins are cyclical. As industries use more and more technology, there is less need for labor and raw materials.
There may not be room for profit margins to expand in the coming months. They may even start coming down.
Employers are also bracing for wage hikes. If expenses are increasing, so are costs for business. But wage inflation also affects consumers by providing more spendable income. However, if employees receive these pay wages, the money is more likely to go to daily needs than more stocks.
Risks in 2022
We don’t see anything that is a cause for alarm, but some areas pose higher risks to investors. They are:
- High inflation. Should you be worried about inflation? Read more here.
- Geopolitical concerns as we enter a political season that could lead to high volatility.
- Annual pullback in the stock market.
On average, the stock market sees a drawdown of 14% each year. This pullback will eventually return, but the bounceback has been much quicker in recent years and has made some investors complacent. Although the Fed stepped in and offset this drop in years past, likely, they will not participate in 2022. The stock market will go back up in the long term, but it won’t be as smooth of a ride as we have seen in the past couple of years.
Our Recommendations for Investors in 2022
Your best path forward this year is to stay disciplined and stay diversified. In the past, the economy and investors have been driven by US large-cap stocks, but not only are there other options, but large-cap stocks may not be the best strategy anymore.
We also recommend paying attention to valuations. If you own a stock with a high valuation, it’s best to have a good level of conviction about its growth. You may also want to consider shifting certain stocks from growth to value.
If you are a OneAscent client, we want to assure you that our team of investment analysts and portfolio specialists are aware of these projections and actively seeking the best decisions based on all that 2022 will hold. We are always monitoring long-term allocation and ensuring your investments are aligned. If you have any questions or concerns, your advisor is a phone call away!
Starting Your Investment Journey In 2022
If you plan to begin or reevaluate your investment journey in 2022, we recommend starting by asking yourself what your goals are and what your ideal timeline looks like. This is also an excellent opportunity to think about what your values are. What areas do you want to invest in, and what beliefs would you never want to compromise on just to make a profit? Learn more about a values-aligned investment strategy here.
Lastly, try not to get caught up in fads or the “next big thing.” Asset classes shift over time, so centralizing your investment strategy on what’s popular won’t provide you with a secure, long-term strategy.
Reach out to us today to learn more about how we can help you build an investment portfolio that focuses on reaching your financial goals while aligning with what matters most to you.