2021: A Rise in Asset Prices
We have learned from experience how our stock market-related investments act as long-term hedges against inflation. As the economic recovery from the COVID shutdowns continues to move forward, we’re seeing how the related inflationary policies have benefited investors.
Prices are rising all around us: energy, food, automobile, and housing prices to name a few. These prices are reflected in the stock indexes as increases in corporate revenue and profit, the ultimate drivers of stock prices. Consider, for example, a business that passes along a price increase to its consumers as the underlying company costs increase along with demand for their products. The consumer pays more for the good or service increasing in turn the business’s revenue, and as its revenues increase the business’s value appreciates.
There has been an extraordinary amount of stimulus injected into the global economy since the shutdowns, which has resulted in significant increase in demand. The definition of inflation, too much money chasing too few goods and services, is playing out before our eyes. Inflationary pressures are reflected in most asset prices, and specific to the investor class, stock values have increased as a result.
2022: Unwinding Inflation
It is likely the ongoing pandemic along with monetary and fiscal policies adopted to address global shutdowns will create headwinds in 2022. Contributing factors include interest rate policy, inflation, COVID variants, government policy (e.g., government spending related to “Build Back Better”), and mid-term elections. A more rapidly rising interest-rate environment has the potential to make equity market investments less attractive and could slow growth.
As could inflation, a significant driver of short-term market moves and increased volatility as we have seen recently; the Federal Reserve speaks and the headline-driven pullbacks and subsequent rebounds occur as the markets consider the potential outcomes.
As the Federal Reserve no longer describes inflation as “transitory” and attempts to navigate a soft landing, we expect monetary policy to tighten. Tightening will be in the form of tapering the Fed’s bond buying and interest rate increases to hedge against significant inflationary pressure. The question is likely not if interest rates will rise, but rather how quickly. COVID-19 and its variants are still going to be in the headlines for some time, but as we saw with the most recent Omicron variant, the markets corrected upwards quickly.
Government policy on spending could change, though that is less likely in light of significant tax law changes and concern over increases in additional spending. Moving closer to mid-term elections could lessen the chances of significant legislation being passed, including Build Back Better in its current form. Historically, gridlock has not created negative economic scenarios.
On a more positive note, there are economic tailwinds moving us into 2022, including large cash positions for consumers and businesses, strong consumer spending, rising asset prices, and relatively low interest rates (even with potential for increases). The record cash positions for consumers and businesses are providing a downside cushion for the economy. Unlike 2008 and the Great Recession, balance sheets are awash with cash. If consumers continue to feel confident, cash holdings will decline providing more fuel for the economy. Rising asset prices have historically led to an increase in consumer confidence, again improving the odds for continued economic growth. With interest rates still relatively low, moderate increases shouldn’t negatively impact the economy; rapid, substantial increases are the bearish scenario.
Given the amount of variables in the economy, we can expect ongoing volatility as we navigate our economic headwinds and tailwinds in 2022. Headlines can drive short-term volatility in the markets, and 2021 has provided sufficient evidence with quick market downturns followed by swift rebounds. Attempting to time the moves is futile. It is best to remove emotion from investing and continue with your plan, including rebalancing your holdings periodically as the markets appreciate over time.
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