As we have promised in the past, we want to write to you when we think we can add insight into what is happening in the financial markets. This time of year, many sources offer their year-end summaries or their 2022 forecasts. The summaries might be a nice reminder and accurate, but they are the past. The forecasts might be thought-provoking and detailed, but most of them will be wrong. What we want to share with you are our thoughts on why volatility (up and down swings) in the financial markets has picked up over the past few months and may well continue into 2022.
For much of the first half of 2021 and into the second half, the financial markets, especially the US stock market, performed strongly. As of this writing, the S&P 500 is up 29.4% year-to-date. Simplifying for brevity, the stock market had three big tailwinds to help it climb higher in 2021. First, the Federal Reserve (Fed) was still very accommodative, keeping interest rates low and supporting the bond market through its purchases of assets. Second, the economy experienced a spending boom as vaccines and reopenings released pent-up demand from consumers who were cooped up under covid restrictions. Finally, large government stimulus and the promise of huge government spending programs on infrastructure as well as the president’s Build Back Better Plan made investors feel economic support would continue for the next several years. By October, the financial markets began to realize that these tailwinds had turned into potential headwinds for 2022.
Inflation has now become a real concern. Supply chain disruptions have caused too much money to chase too few goods, leading to inflation. This has made the Fed pivot from being very accommodative to more restrictive in a short amount of time. Bond purchases are being tapered and interest rate increases are being telegraphed for 2022. Covid 3.0 (Omicron) came on the horizon in the second half of 2021. Just as we thought covid was going away, it has come roaring back. Thankfully, this version does not seem to be quite as deadly, but it is causing a global economic slowdown, at least momentarily, of what had been a been big global reopening. Lastly, the infrastructure bill got passed, but it is hampered by supply chain issues and lingering difficulty in hiring employees. The Build Back Better bill died before the holidays and seems unlikely to resurface in 2022 without significant changes to its largesse.
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The reversals from the Fed, covid and the government are what caused much of the volatility in late 2021 and we think it will likely continue into 2022. Each of these previous tailwinds, now headwinds, impacts big parts of the financial markets differently. Higher interest rates caused by changes in Fed policy are bad in the short term for bonds and for growth stocks, with their earnings further out in the future. Inflation, if it continues to gain traction, could prove challenging for many companies. Some firms will be able to pass on price increases to consumers, but some may not. Companies that cannot pass on price increases will see inflation eat at their profit margins and erode earnings. Covid keeps moving markets because a large swath of investors have money on the reopening trade (travel, entertainment stocks) versus the closed-economy trade (online purchasing, work-from-home stocks). Also, if the government goes from a spending focus to a balanced budget focus, the markets will need to adjust their thoughts on how fast future economic growth might be. The headlines mentioned above are constantly evolving. These changes cause volatility in the markets as huge investment flows react to every bit of news.
The good news is that we at Bill Few Associates do not change our investment process with the headlines. We attempt to build solid portfolios that balance risk versus reward in multiple scenarios. We invest in both growth and value stocks. We continue to hold bonds to protect principal and limit volatility, even if interest rates are low and unexciting. As a point of reference, we like to recall Y2K. On 12/31/1999, the concern was that computers were going to fail because they were not programmed to handle a new century and the year 2000. It was a real fear at the time. Some investors went to cash and sold everything. Now, many investors, having enjoyed a record bull market, seem ready to place all-or-nothing bets on the financial markets. This in-and-out money is what causes volatility. We invest for the long term. We will be in the financial markets all the time, with a balanced portfolio that can weather storms and participate in the good times. It has worked since our founding in 1986, and we think it will work well into the future.
If you have questions about this information or your overall financial plan, call us today at 412-630-6000. Our experienced financial advisors are here to help.
Mike Kauffelt, CFA, Co-CIO
(412) 630-6001 fax
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