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January Commentary & 4th Quarter 2021 Recap
Despite increased volatility in the 4th quarter of 2021, stocks finished strong for the third straight year, with the S&P 500 gaining 26.9% for the year. The combination of increased vaccinations, stimulus checks from the government, and massive liquidity from the Fed fueled higher stock prices.
Beneath the surface of continued uncertainty about Covid, higher inflation and labor challenges, the economy has remained in recovery and expansion. Corporate earnings were as strong as they’ve been in years, up 45% with revenue up 15.7% on average for large, publicly traded companies. Higher revenues and earnings are expected to continue into 2022 with revenues and earnings projected to rise 7.3% and 8.8%, respectively. Earnings are the number one driver of stock prices, which is why we remain positive about the stock market headed into 2022, despite the likelihood of higher interest rates dampening some of the growth.
Corporations have been extremely resilient, adapting quickly to changing conditions – mandated shutdowns and worker shortages, supply-chain issues, inflationary pressures, and several Covid variants. Yet, profit margins stand at all-time highs of 13.5%. We believe innovation, conversion to digital technology, and creativity will continue to fuel high profit margins over the next few years.
The biggest concern facing investors is inflation, which now stands at a 39-year high. Inflation is caused by too much money chasing too few goods and the combination of more government stimulus and the Fed borrowing has exacerbated the problem. We would not be surprised if the Fed’s stimulus strategy ended in the spring and the fed funds rate was gradually increased.
Higher inflation tends to cause interest rates to rise as lenders demand a higher stream of income to compensate for the loss of purchasing power. Over the last few months, we’ve seen the 10-year Treasury rise to over 1.76%, which is above pre-Covid levels. We expect the 10-year Treasury to rise above 2% this year, muting the returns on bonds and other fixed income.
BOTTOM LINE
Stocks had their third straight year of strong returns as corporations adapted quickly to challenging conditions. We believe that as supply chain issues subside and inflation moderates, the economy will continue to grow. We remain optimistic about 2022, but we expect more muted returns on stocks and a challenging year for bonds if interest rates rise in line with expectations.
