Hello friends, Happy New Year and welcome to the first market outlook of 2022. We hope this note finds you and your families well, 2021 ended on a good note and you’re feeling optimistic about the world and financial markets in 2022. I don’t know about you, but for me, the last two years felt liked they merged and we had one ultra-long and equally challenging year. Here’s to hoping the light we’ve been searching for emerges in 2022.
We believe 2022 will be the year of transition, whether it’s in regards to COVID, politics or monetary policy. Unfortunately, Omicron continues to spread like wild fire. 10 million people globally tested positive for COVID in the last 7 days. Here’s the good news that brings hope- the death rate continues to drop. We’ve said this before, but this is the natural progression of pandemics. Eventually, it will become an endemic, no one knows when. To be clear, endemic does not mean no more infections, illness or death. Nor does it mean that each strain will be milder. Simply put, it indicates that immunity and infections will have reached a steady state, meaning no level of immunity will deny the virus a host. However, not enough people will be vulnerable to spark a widespread outbreak anymore. With hope, the world will enter a transition period later this year. This transition period will be bumpy and will look wildly different across the globe. Both the common cold and the flu are endemics and will remain that way. COVID will be much of the same, eventually.
2022 will also be a big year for global elections. Here’s a quick rundown of which countries will be heading to the polls: South Korea, France, Hungary, Philippines, Australia, Colombia, Kenya, Brazil and the U.S. I would argue the two most important are France and the U.S. If Macron, the E.U.’s most prominent power broker following the departure of Merkel, is defeated, the entire future of the Union will arguably take center stage. In the U.S. we head to the polls on November 8th to elect members of the House of Representatives and a third of the Senate. Mid-term elections are traditionally bad news for the sitting President’s party. On average, over the last 7 decades, they lose 25 House seats. What’s at risk is the Build Back Better bill, which has not passed despite the Democrats controlling both the House and Senate. In our humble opinion, the mid-term elections will set the stage for the 2024 Presidential election. You also can’t rule out another round of stimulus prior to the election, as every politician’s primary goal is to stay in office.
The tides of the world’s central banks are no longer crashing ashore creating the massive pools of liquidity financial markets have enjoyed over the last decade. Not many people seem to realize this, but The Fed is ending a 1.5 Trillion dollar Quantitative Easing program in the next 3 months. Due to inflationary pressures persisting, we believe the Fed will be far more aggressive than the current consensus. Rate hikes aren’t just likely, but almost certain at this point. In fact, it’s our opinion that the Fed can raise rates by 100 basis points this year. If our expectation comes to fruition, a general valuation reset lower will occur in stocks. Across history, when rates rise by 100 basis points, the result is a 15% valuation reset lower for stocks. 2021 was a great year for stocks with the S&P up nearly 27%. There were two contributing factors- corporate earnings increased faster than Wall Street projections, and historic inflows to equities from retail investors. Next year, we expect the opposite. Corporate profits will be eroded due to rising wages, increased debt payments and supply chain dislocations. As we progress into 2022, a new regime of volatility will present itself. This new era will cause a hard rotation from growth to value. Add in the headwinds we just mentioned, and there’s a really possibility the S&P can have a negative return this year. Yes, I know it hasn’t happened in a while, but stocks can go down. Hard to believe though when 17 of the last 19 years have produced positive S&P returns. Eventually, you always revert back to the mean. I cannot stress this enough, the setup entering 2022 could not be more opposite than 2021, and for the last decade for that matter. What worked for the last decade, probably doesn’t this time around.
Last but not least, we face significant geopolitical tensions. We don’t envision an actual war unfolding, but a cold war is a significant possibility. As we navigate 2022, there’s the possibility of conflict arising on three different continents. You have tensions boiling between Israel and Palestine, China and Taiwan and Russia and Ukraine. After years of low volatility and excess stock returns compared to history, this year could be different.
Take care, and please reach out with any questions.
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