It turned out that 2020 was the greatest one-year M2 money supply increase in the 150-year history that we have such data. That money was going to the financial markets pushing up prices and then broke out into inflation in 2021. Whereas U.S. economic growth was accelerating in early 2021, now it is decelerating. Inflation has awoken from its slumber and ultra-loose monetary policy has shifted toward tightening. The Fed will finish winding down its asset purchase program and is expected to start increasing interest rates in March. Going forward, the tailwinds of policy support, pent-up demand, and sidelined cash will conflict with the headwinds of equity valuation and inflation likely causing more volatile market returns. Further headwinds are identified by Hoisington Investment Management in their recent report:
“ In 2022, several headwinds will weigh on the U.S. economy. These include negative real interest rates combined with a massive debt overhang, poor domestic and global demographics, and a foreign sector that will drain growth from the domestic economy. The EM and AD economies will both serve to be a restraint on U.S. growth this year and perhaps significantly longer. The negative real interest rates signal that capital is being destroyed and with it the incentive to plough funds into physical investment.”
These mentioned headwinds could ultimately temper inflation and growth. We have attached the full report for your reading.
U.S. stocks finished 2021 near fresh record highs, having posted their third consecutive year of double-digit gains thanks to a strong economic rebound that helped the market weather the ongoing waves of the coronavirus pandemic. Value stocks took the lead in the small and mid-cap space but large growth stocks edged out large value stocks. Energy was the best performing sector with the Utilities finishing last. Foreign stocks in aggregate continued to lag the U.S. According to Factset analysts are projecting earnings growth of 9.4% and revenue growth of 7.6% for the S&P 500 in 2022. The forward 12-month P/E ratio is 21.1. This P/E ratio is above the 5-year average of 18.5 and above the 10-year average of 16.6.
Surging inflation sent bond prices lower, leading key bond market indexes to post their first losses since 2013. Interest-rate sensitive corners of the bond market fared the worst. The Aggregate Bond Index ended the year down 1.5%. Across the globe, government bonds fell as central banks battled inflation. Excluding the U.S., government bonds declined 11%, their worst year since 2005. Only high-yield and inflation-protected bonds ended the year in positive territory. High-yield bonds gained 5.2% and outperformed U.S. core and corporate bonds for the second year in a row.
Equities and Fixed Income continue to be significantly overvalued from a historical perspective given the influence of low interest rates. With Fed Policy changing from Quantitative Easing to Quantitative Tightening, stock earnings multiples will likely trend from expansion to contraction and bonds prices from rising to declining. Therefore we have an underweight to equities and we are utilizing lower interest sensitivity fixed income strategies to complement our fixed income position. Attractive opportunities and valuations are found in select strategies in the private markets. For our qualified investors we are recommending additional weight to secondary private equity investments trading at significant discounts and small mezzanine investments providing higher yields.
Director of Consulting
Timothy J. Vos, CIMA, AIFA
Director of Research
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