The U.S. Economy remains strong; we believe stock returns have the potential to deliver positive returns in 2022.
Sector allocation will be an important driver of returns; small caps and commodities remain a central focus. We favor a defensive tilt.
Returns for many asset classes could depend not just on when but also how forcefully the Fed raises rates.
Given a year of lockdowns, labor shortages, supply chain clogs, and inflationary pressures, most people, we believe, will welcome a more stable, predictable, less dramatic year. Without the Fed fueling the economy with monetary and fiscal stimuli, GDP may be less than in 2021, hovering around 3.9%, but consumers seem alive and well and in a robust spending mood.
We largely agree with the analysts at FactSet, who estimate an earnings growth rate for the S&P 500 of 9.0% in 2022. Industrials, consumer discretionary, and energy sectors should lead the way. We predict spending and GDP will be higher in Q4 than Q3.
Corrections or downturns are an inherent part of the world of investing. As we have written in past newsletters, they are not a function of time. No quarter or year is “due” for a correction. This is a false premise. They may occur at any time and are generally short-lived
Corrections happen when investors lose confidence and conviction in the markets. We do not see convincing and sustainable evidence that investors are losing faith in equities.
We are seeing a reversion to the mean in the economy and in society, or, as Warren Harding called it, “a return to normalcy.”
Pres. Harding, by the way, made his famous statement at the end of the Spanish Influenza, predicting that people would soon return to the lives they led before the pandemic. Data suggest that consumer buying and retail sales are starting to resembles pre-pandemic activity.
A little inflation is good for the economy; it acts as a gentle catalyst for profits and wages. The problem occurs when inflation outpaces individual income. We have given our advice in the past few months about hedges against inflation. We still believe that equities are the best investment to offset rising prices.
Earnings have been impressive during 2021, and we are prepared for a potential deceleration of earnings in 2022. Companies can and will be profitable in 2022, and selecting those companies with strong earnings potential and strong fundamentals will be out priority. There are companies that are able to pass price increases to consumers will often have revenue and earnings growth during inflationary periods, which explains the outstanding numbers for Walmart, Target, and TJX Companies this past quarter.
Slowing Down is not Recessionary
We now expect slower but continuing economic growth in the U.S. It is important to remember slowing down is not recessionary. Our technical indicators affirm our positions to remain in equities, despite much noise for diminished equity returns, negative returns on bonds, and increased volatility across asset classes. Not every year can deliver the double-digit returns we’ve grown accustomed to over the past year.
Inflation and Government Policy are still the primary risks to consider for stocks. We’ve seen the effects so far in recent negative returns for low-quality and speculative stocks. Our position at this time is to look toward companies with high-quality factors such as strong P&E ratios, upward earnings revisions, positive balance sheets, sustainable profit margins, and reliable cash flow.
We are also taking historical ques. Small caps and commodities have traditionally done well in this environment. We believe that the Fed will make several incremental interest rate increases early in 2022, which should benefit banks and financials. Inflation and the Build Back Better bill, should it be eventually passed, should have a favorable effect on REITS. Rising interest rates may take some of the air out of high valuation stocks.
Our goal of seeking to make positive returns in the stock market will not change in 2022. We will follow our discipline and monitor the underlying macro-economic trends in the market with a risk- conscience approach.
