“It is better to sleep on things beforehand than lie awake about them afterwards”-Baltasar Gracian
We find it cathartic taking time at yearend to reflect upon how our predictions transpired in 2021. Our initial projections included the belief that economic growth would accelerate through the year driven by federal relief programs as well as fewer covid related headwinds, both of which occurred. However, we also thought that the Federal Reserve’s revised policy of accepting higher inflation would push bond yields higher and pressure stock valuations and that didn’t play out as equity markets experience another strong year. Thankfully, we don’t practice market timing but, instead, use our forecast as guideposts to navigate possible market conditions. In this note, we will share our thoughts related to potential market factors awaiting us.
We think the core theme of 2022 will be the Federal Reserve’s stated intention to taper its bond purchasing program and to begin raising interest rates. The Federal Reserve last raised rates from late 2016 through 2018 when it hiked the Fed Funds rate eight times. Equity markets remained strong in 2017 but stumbled in 2018 as the Fed Funds hit 2.25% and a trade war with China was initiated.
Inflation is another area on which we’ll be focusing. Prior to the pandemic the consumer price index was averaging 2%. It collapsed in the height of the pandemic to 0% but snapped back to 6.8% in November. Fed Chairman Powell cautioned in recent testimony not to refer to inflationary pressures as transient. This suggests that the Fed is returning to its traditional role of inflation fighter and rates will move higher until inflation moderates. Stock valuations are sensitive to rising interest rates and, like we predicted last year, this could be a headwind for equities. The 2022 projected P/E of the S&P 500 is 21x and over the last 10 years it has traded in a range between 17-26x. This suggests that stocks, while not cheap, are not overly expensive so a modest year for stocks in a rising interest rate environment is our bet.
According to The Conference Board, GDP expanded by 5.6% in 2021 and is projected to grow by 3.5% in 2022. Corporate earnings are forecast to grow in the mid-single digit range as some businesses experience margin compression driven by higher input costs. Many of the businesses we own have pricing power, enabling them to pass along higher costs. We also think that if rates move higher and investors become more risk averse, owning businesses generating free cash flow will perform better.
Thank you for entrusting us with the management of your money. We look forward to speaking with you in the coming weeks. Happy New Year!
JM Sam Nevin, Jr.
W. Joseph Ryan III
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