Brian J. Murphy, CIMA®
Senior Vice President, Chief Investment Strategist
[email protected]941.366.7222 x41933
The year 2021 saw a significant rebound in economic growth propelling real GDP above its
pre-pandemic level. Equity markets followed along, making new highs throughout the year
as corporate earnings continued their recovery. While the final numbers aren’t in yet, the
expectation is that U.S. GDP grew at roughly 5.6%1 in 2021 and will likely carry that momentum
into the first half of 2022 before slowing down later in the year. Not surprisingly, the primary
driver of economic growth was the U.S. consumer who unleashed a wave of spending fueled
by government stimulus payments, increased savings rates, and pent-up demand following
2020’s lockdowns.
Aiding the recovery was a significant uptick in labor demand. Businesses rehired workers
and added new jobs to meet increased demand, bringing the unemployment rate from 6.7%
at the start of the year down to roughly 4.2% by year-end. As a sign of the ongoing labor
market’s strength, most recent data showed more than 11 million unfilled job openings,2 an all
time record. This strength has led to meaningful wage increases as businesses competed for
workers to fill positions.
The flip side of this unprecedented recovery has been one of the most substantial increases
in inflation that we’ve seen in decades. Unsurprisingly, when significantly elevated cash levels
from government stimulus payments and Federal Reserve balance sheet expansion met a
wave of demand that couldn’t be filled due to supply chain issues, prices rose. As it stands,
the U.S. Consumer Price Index ended November at 6.9% (annualized) and has been far more
robust, in both its level and duration, than the Fed anticipated. By year-end, this prompted
the Fed to begin a more aggressive tapering of its bond purchase program, which it will now
likely wind down by March. This sets up the potential for a Fed Funds rate increase by spring,
with others later in the year.
|
S&P 500 |
28.71% |
Russell 1000 Growth |
27.60% |
Russell 1000 Value |
25.16% |
Russell 2000 Value |
28.27% |
Dow Jones US Real Estate |
38.99% |
MSCI EAFE (net) |
11.26% |
MSCI Emerging Markets (net) |
-2.54% |
Bloomberg US Aggregate Bond |
-1.54% |
Bloomberg Municipal Bond |
1.52% |
Bloomberg High Yield Bond |
5.28% |
Source: Zephyr/Informa Investment Solutions |
U.S. equities had another outstanding year, with the S&P 500 up 28.7% on back
of strong earnings growth. Both revenues and profits continually exceeded
expectations over the course of the year as companies fought to keep up
with consumer demand. By year-end, even with the sharp increase in the
S&P level (price), overall valuations had moderated, with the forward price-to-
earnings ratio falling from 22.4x to 21.4x.3 While still well above historical
averages, this level continues to be supported by low interest rates, a strong
consumer, and increased government spending. The question moving into
2022 is whether the likely increase in rates, along with moderating GDP
growth, unsettles equity investors.
The rising tide lifted all boats, and equities fared well across the style and
market capitalization spectrum with most U.S. asset classes up over 20%.
Generally, small cap stocks lagged large caps, but small cap value stocks did
very well with the Russell 2000 Value Index up over 28%. Also of note, real
estate did exceptionally well, returning over 39% as measured by the Dow Jones U.S. Real Estate Index as the asset class continued its
recovery and investors sought yield and potential inflation
hedges.
Internationally, developed market equities fared well but
lagged U.S. returns with the MSCI EAFE Net Index up 11.2%.
Conversely, emerging markets struggled on weakness in China,
and the MSCI Emerging Market Net Index was down 2.6% for
the year.
Fixed income returns, outside of high yield credit, were
generally negative for the year as prices dropped with rising
rates. Yields, which continue to be extremely low, were not
enough to offset the weakness in prices, leading the Bloomberg
U.S. Aggregate Bond Index to post a -1.5% return for the year.
For bond investors, the only areas of the market that provided
meaningful returns were in high yield (below investment grade)
and inflation protected securities (TIPS).
The fixed income outlook for next year doesn’t look much
better, as the Fed will likely begin raising rates to combat
inflation. This will lead to more weakness in bond prices as the
yield curve adjusts to higher rates. For the near-term, bond
investors will need to focus on the diversification benefits of
owning fixed income, understanding their role in dampening
volatility in portfolios that own equities.
CPI: Consumer Price Index, PCE: Personal Consumption Expenditures
Source: Northern Trust, information as of 10/31/21
Inflation would seem to be the lynchpin in 2022. Is it short-lived
and likely to fade as we go through the year, or does it become
embedded in the economy? Right now, the camps seem split,
with arguments being made to support either argument. But one
thing is almost certain: Its trajectory will play a significant role
in how 2022 unfolds from a market and economic perspective.
Asset prices have been buoyed by easy monetary policy for
over a decade, and if the punch bowl is removed by a Fed that
is forced to be more aggressive with rates, then equity markets
may bear the brunt of investor angst. Either way, given current
U.S. equity valuations, it’s likely that returns moderate over the
next few years as they take a breather from their recent pace.
Of course, the virus will also play a substantial part in 2022.
Covid-19 has taken a horrible toll on us as a country, with
over 800,000 people having died from the disease and its
complications. Yet many have decided to return to a more
normal lifestyle, and there is little appetite for additional
restrictions on schools and businesses. At the same time,
hospital systems and workers can only endure so much, and
the government will need to do what it can to protect them
and their ability to function and provide vital services. Any
restrictions, whether in the U.S. or internationally, could limit
economic growth through lost revenues and the exacerbation
of supply chain issues. Equity markets will continue to factor
in the virus news flow as they attempt to ascertain the likely
winners and losers, and the Fed will also need to weigh its
policy decisions carefully in a very uncertain environment.
Our expectation is that the global economic recovery will
continue in 2022 with GDP growth and inflation beginning
to moderate toward more normal levels as we go through
the second half of the year. Challenges will be posed by the
uncertain path of the virus, and the Fed will have its hands full
balancing the desire to fight inflation while not undermining
asset prices, but for long-term investors the path ahead remains
the same. A diversified portfolio of equities, with allocations
across various capitalizations, styles, and geographic regions,
remains the best way to grow wealth over the long-term, and
while bonds may be handicapped in the short-term, they still
provide stability in difficult periods.
Our investment committee will continue to actively discuss
all of these factors and make adjustments in light of new
opportunities or to help mitigate risks based on market
conditions. As always, we are here to help keep your financial
plan on track to meet your life goals. Please contact your
advisor if you have any questions or concerns, and we wish
you and your family all the best in the New Year.
Data as of 12/31/2021. Sources: 1The Conference Board December forecast, 2Bureau of Labor Statistics JOLTS report, and 3FactSet as of 12/31/21.
This material is provided for general information purposes only. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Bank & Trust or its affiliates, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.