There were a multitude of challenges across the globe in 2021, foremost the relentless impact of the Covid-19 pandemic and two new variants Delta and Omicron. Fevered political discord, including the horrific January 6, Fed interest rate guidance, supply chain disruption, and rising inflation all contributed, while historic fiscal and monetary stimulus served to further the economic recovery. Yet, the global financial markets absorbed those challenges with resolve and optimism, as vaccination rates soared, and stocks rose for the third straight year.

US stocks posted a plethora of all-time highs across the board in 2021, including 70 for the S&P 500 (CNBC) which rose a leading 26.9% for the year. Interestingly, the S&P 500 hit a record high at some point during every month of the year. Mid-cap stocks, as measured by the S&P 400, provided leadership for much of the year as well and closed with a gain of 23.2%. Despite an uneven year for technology and growth stocks, given sensitivity to rising interest rates, Nasdaq still posted a 21.4% gain. While small-caps rose 13.7% for the year, as measured by the Russell 2000, they dipped 2.8% in the second half and lagged overall. The Dow Jones Industrials jumped a leading 5.4% in December, on its way to a strong 18.7% gain for the year.

Markets overseas were faced with the same pandemic challenges, with governments and central banks running the same playbooks of fiscal and monetary support of their economies. Returns were more muted, with the benchmark MSCI EAFE index gaining 8.8% for the year. Emerging markets, however, struggled posting a loss of 4.6%, largely due to China.

Interest rates rose across the yield curve in 2021, but hardly in a straight line as investors reacted to policy guidance by the Fed, rising inflation, and strong economic numbers throughout the year. The Fed’s pivot on inflation at the end of November and ramp-up of the pace of its tapering of asset purchases in December, against a burgeoning balance sheet, sent a message to the markets. At the last FOMC meeting in December, the Fed expects that as supply chain constraints ease in 2022, inflation will ease from the current elevated levels, but likely remain “sticky” and above its 2.0% long-term target.  The Fed projects three rate hikes in 2022 towards policy normalization. The benchmark 10-year Treasury Note yield rose 59 basis points in 2021 to 1.52%

The Outlook

A year ago, we viewed 2021 as a year of transitions, as vaccination success would further the economic reopening and recovery, paving the path forward to a return to normalcy. Supported by historic fiscal stimulus (American Rescue Plan and Infrastructure Bill) and Fed monetary stimulus totaling over $4 trillion combined, the US economy is projected by the Fed to grow 5.5% in 2021 and 4% in 2022, both well above historic trends. Unemployment plunged to 3.9% in December, from 6.7% at the end of 2020. With Q4 -21 S&P 500 earnings growth expected to top 21% by FactSet, that would make four straight quarters of 20%-plus earnings growth. With that earnings growth came price-earnings multiple expansion in the market as US stocks hit record highs in 2021.

We see 2022 as another year of transitions, with encouraging potential for Covid-19 to move from pandemic to endemic, but one of increased volatility amid reduced fiscal and monetary policy support, rising interest rates, stubborn inflation, geopolitical tensions, and Mid-Term elections. While we forecast more modest returns in 2022, following three years of strong gains, our market and investment posture, despite anticipated volatility, remains cautiously optimistic for the New Year. However, we continue to urge investors not to get complacent with risk, stay diversified, and maintain a long-term focus.

Point by Point

• The Fed has already pivoted on inflation and is getting more aggressive on tapering its bond purchases, and projecting at least three rate hikes in 2022 beginning as early as March. Reducing its balance sheet will come as well. If inflation doesn't subside as anticipated, the Fed may need to raise rates more aggressively.

• Rising interest rates present challenges to bonds, as bond prices and yields move in the opposite direction, and stocks, as cost of capital increases impacts earnings. We maintain a defensive emphasis on short-term bonds and high quality. Normalization of interest rates will be a multi-year process.

• Mid-Term elections have historically brought elevated market volatility leading up to Election Day, but markets have typically bounced back strongly after* (Capital Group)
• Volatility in stocks is anticipated to increase; a correction and periodic pullbacks are normal and would be consistent with the above transitions but seen as buying opportunities
• Covid-19 pandemic could transition to an endemic with further vaccination progress, the Omicron variant proves less threatening, and no more severe variants emerge; however, the longer it prevails the longer the road to normalcy
• While historic fiscal and monetary support is expected to wane, there are still trillions of dollars of investment and accommodation in the system paying dividends longer-term

• 2021 corporate earnings were stellar, but 2022 is expected to see a slow down to 9.4% (FactSet)

• International stocks remain attractive relative to US stocks following a decade of underperformance; we've increased international exposure but remain modestly underweight

• Russian troop build up at the Ukraine boarder and invasion threat adds to uncertainty

• Maintain diversification, discipline, and keep your focus long-term

• Refrain from chasing returns and making large portfolio changes

• Maintain regular contributions and a rebalancing program

January 2022 Volatility Update

• Anticipated increase in volatility for 2022 has wasted no time showing up, with US equity markets down 5-10% to start the year, ending 1-21-22
• Tech and growth heavy Nasdaq, as well as small-caps, have led on the downside
• Markets overseas have seen increased volatility as well, but have outperformed the US, on a relative basis, down just 2.2%
• Rising interest rates, including increased expectations of additional Fed interest rate hikes in 2022 from three to four, have accelerated the market's recalibration
• Growing tensions between the US and Russia over building troop presence at the border of Ukraine and threatening invasion have contributed as well
• Remember, corrections and pullbacks are normal for markets any year, especially after periods of strong gains
• From the Covid-19 low on 3-23-20, the S&P 500 is up 96.6% ending 1-21-22
• We encourage investors to remain resilient and patient 
  

Call your Nelson Advisor today at 800-345-7593 to discuss any concerns and review your portfolio.   

 ~Your Nelson Securities Team    

*Past Performance is No Guarantee for Future Results 

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