The year ended on a high note for the Dow and S&P 500 despite economic challenges posed by the coronavirus and extreme weather events.
While the traditional end of year Santa Claus equity rally may not have been as pronounced as we typically see, it may have just come early. Thus far, we’ve seen both the Dow Jones Industrial Average and the S&P 500 notch new highs in December with underlying market sectors firmly in the green.
Despite the challenges posed by coronavirus variants and extreme weather events, 2021 saw the best economic growth since 1984, muted market volatility and the S&P 500 delivering a return of approximately 27% over the course of the year. Raymond James Chief Investment Officer Larry Adam expects inflation to peak by early next year, which should alleviate pressure on the Federal Reserve (Fed) in the upcoming tightening cycle and would be supportive of domestic equity markets overall. The situation remains fluid, but there’s general optimism that the global reopening will continue and inflationary pressure will subside. Both will be key factors for markets, economic growth and corporate earnings throughout 2022.
This year-end equity boon didn’t come easy. We saw some volatility amid faltering negotiations to advance President Biden’s Build Back Better legislation and rising geopolitical tensions between Russia and the Ukraine, which have the potential to escalate in the near term. We believe that U.S. lawmakers may eventually unlock a deal in the new year, says Washington Policy Analyst Ed Mills. However, investors can expect to see short-term economic headwinds emerge in the meantime, and consumer sectors may stumble as the monthly child tax credit payments are set to expire as well.
Energy policy
As negotiations in D.C. drag out, clean energy companies in the U.S. market may not be able to count on a decade-long extension of the wind and solar tax credits, a more generous electric vehicle tax credit, or new tax credits for low-carbon fuels and green hydrogen. These provisions may be revived in some form but that remains to be seen. This is a sharp contrast to the European Union climate policy, notes Energy Analyst Pavel Molchanov. For example, Germany’s new coalition government announced plans to phase out coal and mandate 80% renewables in the electricity mix by 2030.
Inflation and interest rates
The overall market feel has not changed a great deal. Inflation is rooted in select products/industries, yet interest rates remain subdued for a myriad of reasons that include inflation longevity doubts, global interest rate disparity, sovereign bias toward amassing debt levels and more complex demographic rationales.
The Fed began to taper the pace of its monthly asset purchases and financial markets seem to have priced in rate hikes sooner than later. The central bankers have stated hikes won’t occur until tapering is complete, most likely around May. Given that monetary policy has been so influential to equity markets post-credit crisis, the Fed’s hawkish pivot from ultra-lenient policy could come with more moderate returns and normal volatility/choppiness over the coming year, notes Joey Madere, Senior Portfolio Analyst, Equity Portfolio & Technical Strategy.
Around the world
Overseas markets faced similar challenges (e.g., a sharp rise in COVID-19 cases; higher gas prices; heightened inflationary pressures), yet European equity markets hit new 2021 highs during December. Corporate earnings growth for 2022 is anticipated to be above 10%, aided by a combination of general global export recovery and the current low level of both the euro and the pound against both the dollar and the Chinese yuan.
During 2021, over 40 global central banks raised interest rates, predominantly in the emerging markets, reflecting both economic recovery and higher inflation. With economic growth rates in China continuing to slow, we believe the world’s largest emerging market is more likely to reduce its interest rates further during 2022.
The bottom line
We expect normal volatility and pullbacks in the year ahead, along with continued sector rotation. Overall conditions are likely to remain healthy, and investors can use these periods to opportunistically and thoughtfully add vetted positions. If you have any questions about your financial plan, please reach out to your financial advisor.
Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. Small cap securities generally involve greater risks. International investing is subject to additional risks, such as currency fluctuations, different financial accounting standards by country, and possible political and economic risks. These risks may be greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.
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