The stock market had another great year during 2021, ending three years of solid returns. These returns are not sustainable for the long run as the stock market has historically earned about 10% per year. The bond market had its first tough year since 2018. Inflation hit levels not seen in over 20 years. Much of this has to do with the fact that the government stimulus put so much money in people’s pockets, more than replacing the lost income during the pandemic. Many people spent it on goods instead of services, causing supply chain issues and driving prices higher across the board.
Much has changed from last year. We are still dealing with a global pandemic, although many hope that we are nearing the end of the pandemic and entering the endemic stage of COVID-19. President Biden passed two different large government programs and is working on another. The Build Back Better plan, as currently proposed, would provide stimulus that will be spread over the next ten years though most of the impact will be in the first six years. This may be inflationary, but it is unlikely to have the same effect on inflation as the three COVID-19 relief bills that passed during 2020, and early 2021 had.
The Federal Reserve is expected to remove accommodation and begin a tightening cycle. Typically, the stock market does well during the first part of the tightening cycle; however, valuations are much higher than average, which may mute returns. In addition, inflation is higher than normal relative to interest rates which could provide a larger headwind than usual to earnings at this point during the cycle. As in 2021, we expect earnings to grow but at a much slower pace and valuations to contract as interest rates rise for the second year in a row.
In summary, we are optimistic that stocks can provide a mid-single-digit return in 2022. We expect the Federal Reserve to raise short-term interest rates and for the bond market to provide a low single-digit loss to a low single-digit gain in 2022. We believe our clients should begin to rebalance their allocation back to target while remaining slightly overweight stocks. As in 2021, we hope there are better opportunities to buy bonds at higher interest rates later in 2022; however, they are already significantly more attractive than at the beginning of 2021.
We look forward to working with you in the coming year and commit to always act in your best interest and strive to earn the trust and confidence you have placed in us. Please feel free to call or email us with any questions. Happy New Year!