Equities have enjoyed strong gains since the pandemic low of 2020, aided by massive monetary and fiscal stimulus, excess consumer savings, and incredibly negative real policy rates and bond yields. 2021 experienced amazing earnings growth, which powered equities higher offset only slightly by rising inflation and interest rates. In fact, earnings expectations exceeded beginning of the year estimates by a record amount as corporate revenue growth and profit margins exceeded expectations. COVID variants entered the mix at a few points, creating some volatility and style rotation. Although it was a tug of war, growth beat value, large beat small, and the U.S. beat non-U.S. equities. Treasury yields ironically reached their high for the year in March (1.75% for 10-year Treasury) and cyclical stocks beat defensive stocks handily.
Risk taking was heavily incentivized by extreme monetary and fiscal reflation. For example, meme stocks captured headlines several times during the year as short squeezes created significant upside in some stocks with little overall market impact. These types of activities were amplified because consumers enjoyed record (more than $2 trillion) excess savings created by government transfer payments and reduced consumption in some COVID-impacted industries.
During the year, one of the most noteworthy developments was a substantial rise in inflation from the less than 2% annual rate that existed for about a decade to nearly 7%, the highest in about 40 years. Belatedly, the Fed admitted that inflation was not transitory and has accelerated its recently announced tapering program, preparing the way for rate hikes in 2022. Policymakers acted as if the economic cycle was fragile and ready to fall into recession even though the threat of deflation had long since ended.
Given these developments, 2022 will likely be more challenging for investors, as the Fed and other central banks progressively unwind accommodative policy in response to the ongoing economic recovery/expansion and elevated inflation readings. While economic and earnings growth are likely to be good, a “too-high” inflation backdrop and rising real interest rates suggest less favorable and more volatile conditions for investors than have prevailed since the pandemic lows.
With this backdrop I proceed as usual with fear and trepidation (and hopefully some good educated guesses) to unveil my prognostications for 2022 in the form of my 10 Predictions.