Nearly four years ago, we wrote a market commentary titled “A New Waze of Investing” in which we highlighted the incredible technological innovations that were changing our everyday lives and our perspectives on long-term investing. Following along with those technologies has been a great benefit over the years in all aspects of life. Still, have you ever taken one of those back-road “short-cuts” to get around a car wreck on the highway ahead, and the next thing you know, by trying to save ten minutes on your hours-long journey, you’re now lost on a dirt road with no cellular service? Suffice it to say, we’ve been there. It’s in those moments that you realize the value of having perspective on your ultimate goal, as well as the value of having patience along the journey.
We see a parallel for markets today, where thousands of drivers enter the market’s thoroughfares every day, each with their own destination, navigating at various speeds, often causing chaos, and the occasional wreck along the way. At any moment, the action is hard to explain, and it can be maddening at times. Are people really slowing to a halt because there’s an accident on the other side of the highway?!?! Keeping focus on your destination and on the structural forces that lay the path for you to get there is key. Distractions from the perpetual news alerts pinging your phone can, on the other hand, leave you calling for help. So, what are the forces carving out the clearest paths for 2022? That is the subject at hand.
Nominal GDP growth will still be solid this year
First, nominal GDP growth is likely to be solid this year, albeit not at 2021’s historic levels. The real economy is being driven by powerful consumer demand, catalyzed by a booming labor market with personal incomes growing 10% year-over-year. Generationally high wage gains will support consumption growth, especially in 2021’s supply-constrained sectors, like autos and housing. In addition, inventories still need to be rebuilt, a significant tailwind for overall production. At the same time, corporations’ intentions for capital expenditures (capex) and research and development (R&D) have accelerated, especially for investments in productivity-enhancing technologies. Thus, the backdrop for earnings growth is still impressive. That said, we would also caution that there are some near-term pressures weighing on growth, as both the Omicron Covid variant has kept consumer behavior from normalizing as rapidly as many expected and lack of product availability has been a headwind too.
Figure 1: Base effects and some easing of supply chain issues moderate inflation by year end
While we are seeing early signs of moderation in supply-chain stresses, economic velocity is now gaining support from increased commercial and industrial (C&I) and consumer lending, which can keep upward pressure on prices for several more months, in our view. Our projection is for Core PCE inflation to ultimately migrate back to the 2.5% to 3.5% range by year-end, as commodity prices plateau near these elevated levels and as many of the logistical bottlenecks loosen up over time (see Figure 1). However, over the coming months, we are preparing for more headline-grabbing inflation data points that could send the media and some traders into a tailspin. Also, clearly there will be some inflation-stickiness from persistently higher wage levels and a corporate sector that is in the luxurious position of being able to raise prices almost at will.