The stock market finished 2021 on a high note, with a strong rally into year-end capping another positive year for stocks overall. U.S. stocks continued their outperformance versus both Developed International stocks and Emerging Market stocks. However, the bond market struggled last year posting a negative 1.54% annual return for the Barclays U.S. Aggregate Bond Index with the market anticipating a less accommodative Federal Reserve policy along with future rate hikes. Heading into the New Year, the economy remains on strong footing with both consumer spending, corporate profit margins, and company earnings continuing to provide support to the economy. Inflation and a more aggressive Fed policy continue to remain risks to the economic recovery, so we will be watching closely to see how both the stock and bond markets handle the Fed beginning to wind down their monthly bond purchases and begin to posture for increasing the Federal Funds Rate.
The Federal Reserve decided in November to begin to taper their bond asset purchases on a monthly basis, initially projecting to end those purchases early summer. In December, the Fed agreed to speed up the reduction in bond purchases to complete the reduction in March this year. This gives the Fed the ability to begin to increase the Fed Funds Rate earlier should they decide a rate hike is warranted as early as March. The Fed also indicated that they might begin to reduce their bond holdings faster than the market expected which caused both the stock and bond market to reprice assets given the possibility of a more aggressive move from the Federal Reserve. It is too soon to determine if the Fed will follow through on the more aggressive policy this year, but the market is currently pricing in three rate hikes in 2022, three more hikes in 2023, and two more hikes in 2024. The Fed continues to say they will remain flexible depending on how inflation and employment readings progress throughout the year.
Inflation continued to surge in the 4th quarter of 2021, leading the Fed to remove the word “transitory” from their Fed statement indicating that they feel some inflationary pressures are going to take longer to return to normal than they previously projected. Global supply chains have shown some signs of improvement with some of the port backlogs improving and some of the largest companies continuing to maneuver well to keep their shelves stocked. However, inflation expectations remain elevated for 2022. Expectations are for inflation to begin to subside as the year progresses, but still ending above the Fed’s 2% goal. Should inflation hold at higher levels than predicted, it could cause the Fed to be more aggressive than current expectations. This would generally be a headwind for markets, especially growth stocks since they tend to perform best in a low interest rate environment. We highlight this as a risk case to watch as the year progresses. 2022 will be a year in which both consumer and corporate spending will need to remain strong in order to offset a reduction in government stimulus spending and a less accommodative Federal Reserve.
Chinese stocks continued their struggles last quarter with the Chinese government expanding their regulatory crackdown on industries they feel are not adding to “common prosperity”. This has forced many of China’s largest technology companies to start to deleverage some of their assets and make donations to the government, which have weighed heavily on the Chinese stock market overall posting negative returns for the year. China remains a large driver of global growth so we will be paying close attention to their moves in 2022 to see if they pivot to a more accommodative policy to restore growth.
While many positives remain for the global economy with global economic growth and company earnings expected to continue to show strong growth in 2022, we maintain our view to be mindful of the risks that the markets face this year from a less accommodative Federal Reserve, elevated inflation, a very contagious Omicron Covid-19 variant, and many different geo-political risks. We recommend staying the course with your investment objectives, and we continue to rebalance and take profits as we see opportunities to protect portfolio gains and keep our portfolios in line with their investment objectives. We also recommend communicating with us if any short-term cash needs arise so we can look for opportunities to be proactive when raising cash for any necessary distributions helping to protect against possible short-term negative moves in the market. We recommend maintaining a more long-term focus on investment goals and objectives with an understanding that short-term headline risks rarely have a long-term effect on markets.