- Economic growth continues to be strong since the rebound in Q3 of 2020.
- Supply chain issues will ease… but when is anyone’s guess (and it would be a guess).
- Inflation is not likely to remain elevated — our base case is 2.5% longer term.
- Consumer confidence remains low despite a rebound in the economy and stock market.
- Stocks are still poised for positive returns in 2022. Who is TINA?
- Bonds keep me up at night, not stocks.
Year in Review
In 2021, the U.S. experienced growth in the economy, equity markets, corporate profits, and employment. U.S. household net worth is at a record high. The most recent household debt service ratio, which measures debt payments as a percentage of personal income, is near an all-time low (record low recorded in Q1 of -2021).1
Unfortunately, we saw growth in supply chain bottlenecks and employees quitting their jobs, which has been termed “The Great Resignation.” There are more open positions in the U.S. than workers who are “actively” seeking employment. Pandemic fatigue set in along with inflation, which drove consumer confidence lower.
Economic Variants and Variance
At times, writing about markets and the economy feels a little like the pandemic. The headlines seem to be the same, but there is variance in the data and some newer “variants” as well. The wall of worry is still here and always will be. Though likely short-term, some of the risks for 2022 include: ?
- COVID-19 /Pandemic: A new variant could cause hesitation of workers, businesses, and the government, causing more disruption and a slower growth rate of the economy and corporate profits. This would be a variant by definition.
- Inflation still appears to be transitory on an intermediate-term basis, but higher for longer would be bad for stocks, especially bond returns. While we anguish over the consumer price index, the Federal Reserve is focused on the personal consumption expenditures price index. The PCE index assumes that consumers change buying habits as prices change. If beef prices rise, consumers buy chicken or the like. The PCE index rose 5.5% over the prior year compared to 7% for the fixed basket of expenses in the CPI. This is an economic variance as we monitor this over every cycle.
- Supply chains have had a negative effect on inflation and our ability to buy goods. Continued disruptions could keep inflation risk higher. The Baltic Dry Index monitors the cost of shipping raw materials by sea. It dropped substantially in October, indicating a reduction in freight costs and the potential easing of raw material costs. Lower demand and lower costs could mean a possible “catching up” of supply chains — an unexpected variant.
- Consumer confidence has rebounded from the November low but is still lower than 90% of the time.3 68% of our economy is consumption. When people are not confident, they don’t want to spend money or invest in stocks. Investors regularly monitor the variance of the monthly confidence report; it is somewhat of a variant due to the surprisingly low reading.
- Mid-term elections will dominate the water cooler and social media as the year progresses. This variant could increase stock market volatility and confidence to a degree. However, it likely will not cause lasting damage to the economy or the stock market.
I delayed the writing of this commentary as the stock and bond markets began their declines in early January. In the mid-year 2021 commentary, I wrote about the potential for a stock market correction, defined as a drop of 10%—20% from the recent market peak. It was not a prediction, just a recollection of past events. To quote Mark Twain, “History doesn’t repeat itself, but it rhymes.” I don’t know if it rhymed or repeated, but it happened!
The broad S&P 500 stock index declined more than -10% in January 2022. Jim Paulsen at Leuthold Group wrote a research note indicating that -10% corrections occurring during periods of low consumer confidence were infrequent, less severe, and did not result in a drop of 20% or more. See the chart below.
- There have been 26 stock market corrections since 1946.
- The average decline has been -13.7%.
- The average recovery has required four months of patience.
Mid-term election years have historically produced negative returns in the first half of the year with positive gains in the second half when party control is similar to today. The net result has been positive average stock market returns of 11% for the full year.2 If we haven’t seen the bottom in stock prices, we will likely see it soon, assuming no other unknown market variants arise.
There is always a reason (excuse) not to invest in stocks, but those excuses have not served long-term investors very well. I would opine that this time is no different. Our base case for the year is for stocks to produce positive, possibly double-digit returns.
A strong economy provides “fertile soil” for corporate profits to increase and a good labor market for individuals and families. Cash and money markets currently pay 0%. Bond returns may be lower than inflation risking future purchasing power. It appears that there is no alternative (TINA) to owning stocks over time.
Millennials, our largest generation, have yet to see peak earnings and spending. With a massive transfer of wealth from savers to investors, this generation provides a long-term tailwind for stocks.
As always, we genuinely appreciate the trust you place in your financial advisor and our firm.
Chief Investment Officer
Legacy Financial Strategies, LLC (“LFS”) is an SEC registeredSEC-registered investment adviser. Information included herein is provided for illustrative and informational purposes only and is subject to change. Some information included herein is derived from outside sources, and although those sources are believed to be reliable, no representation is made by LFS about the accuracy or completeness of such information. All investments involve risk, including loss of principal invested. Past performance does not guarantee future performance.