Dear Clients,
After another strange year, I hope this letter finds you healthy and resilient as we enter 2022.
This pandemic has changed our lifestyle, and in one way or another, we have had to deal with it from its first day of 2021 till its last. The past year started with hope that the vaccine would allow us to return to normal and for a few months we were able to enjoy a “new normal”. Unfortunately, the year ended with COVID cases surging once again.
This pandemic has been hard for someone like me, who likes to travel for business and see friends and family. It has been hardest on those whose health is more vulnerable, who need to be more cautious and who don’t get to see their loved ones as much as they would like. It’s also been very challenging for young adults, who are either in school or starting their careers. Studying or working from home really limits their academic, professional, and social growth. I am reminded of the quote that I shared in last year’s letter about being adaptable. It is still a skill we will need in 2022.
So, on the flip side, I would like to share some funny stories from 2021 with you all, stories that didn’t get a lot of press. Did you know about Saudi Arabia banning forty camels from a camel beauty contest for having altered their looks with Botox and other fillers? Or about the Italian man who tried to dodge the COVID vaccine by wearing a fake arm? And just a few weeks ago, fish literally fell from the sky in Texarkana, Texas! I hope these stories made you laugh, as we all could use a few more laughs these days. Now on to business…
With all of the economic stimulus and the consumer feeling good about spending money, it was not a surprise to see that risk assets (stocks, and real estate) had a banner year in 2021.
Current Market Environment
- Consumers are confident about spending. The data indicates they feel good because their personal finances are in great shape. The average FICO credit score today is 716 (a record high since the score was created in 2005).
- Banks are in relatively good shape - They have a record low 57% loans on their balance sheets compared to the deposits held (low leverage). The recent rise in rates also offers them some considerable benefit.
- Corporate balance sheets are very strong - Tremendous corporate earnings have produced excess cash that they will use to buy other companies, increase dividends, or buy back their own stock. When bonds yield very little, buying back stock becomes very attractive for corporations.
- There is $5.5 trillion dollars on the sidelines in US money market accounts.
- Interest rates are still historically very low (even if the Fed raises the Fed funds rate from current policy of zero to the projected 0.75% before year end). Earnings are projected to be strong. This is a great recipe for a healthy stock market. What could go wrong?
Biggest Risks of 2022
All of these risks are a low probability in our mind, but we will continue to monitor them.
1. COVID’s negative impact on the economy continues longer than anticipated.
2. Inflation and interest rates - Inflation continuing unabated and the Fed losing control of rates is the single biggest risk to our economy. We remain confident that inflation will ease meaningfully in 2022, though price pressures are unlikely to subside quickly. We are already seeing some relief in supply chain logistics. Wage inflation is here to stay as there are just too many job openings (10 million) for the number of unemployed (6 million). This imbalance has given employees powerful leverage for the first time in memory. Keep in mind that our government has a huge incentive to keep rates low. Our national debt is at an all-time high, and they need to keep their interest payments on that debt below historic norms.
3. Political risk in the US around the November 2022 midterm elections - As always, geopolitical risks can rear their head at any time. Most likely culprits are China, Russia, North Korea, and the Middle East (sound familiar?).
Despite all the possible risks mentioned above, the S&P 500 has notched an average total return of 13% in the year following a 20% or more gain according to Truist.
2022 Expectations
Last year, we made ten predictions about the economy and markets. We were correct on 8 of them. We clearly missed when we said inflation would remain in check in 2021 (we did say we were concerned longer term). Our error was in not anticipating that so many workers would retire and that the supply chain disruptions due to COVID would continue. We also pointed out the bubble in both crypto and SPACS. While these assets did pretty well in 2021, some of the air seems to be leaking out of them. Only time will tell, but fundamentally there is no way to justify current valuations. Asset bubbles can continue for a while, but eventually they need to reset to more reasonable valuations.
While the current macro economic environment detailed above is very positive, we believe this year’s performance of the markets is much more difficult to predict, but we will do our best.
1. 2022 Economic growth - Although the fastest pace of the recovery lies behind us, global GDP is likely to grow in the neighborhood of +3% - +5% this year. We expect the first half to be stronger, benefitting from improving virus conditions, economic re-opening, pent-up consumption, and inventory rebuilding.
2. 2022 Corporate earnings – In our opinion, this is the most important driver of stock prices. After the -14% drop in S&P 500 earnings in 2020, earnings grew +47% in 2021 to an all time high. This was 45% higher than the previous record recorded in 2019. We believe earnings growth will be a very respectable high mid-single digit growth figure.
3. Volatility - It has been almost two years since we had a pullback of more than-5% for the S&P 500. This is not normal, and any one of the risks mentioned above could trigger a deeper pullback. Most likely it would be the Fed trying to thread the needle of curbing inflation but keeping the economy’s strength going. There will be a lot of noise around this subject, and that interest will create investment opportunities. But in the end, we believe that their plan is a good one with a high chance of success.
4. Interest rates - Just like 2021, holding very conservative bonds (US Treasuries) will probably cause you to lose value as rates move higher. We continue to favor shorter duration corporate bonds, and tax-free municipal bonds to offset that risk. We expect three interest rate hikes to finally move away from a fed funds rate target of zero.
5. Stocks - Strong earnings, solid balance sheets and relatively low rates will propel stocks higher, our guess is for mid-single digit returns.
Administrative Issues
Each year the SEC requires us to offer you a copy of its Securities and Exchange Commission Form ADV, Part II. This form documents offers standard information on our partnership. If you would like a copy, please let us know.
2021 Tax Documents – 1099’s should arrive in the mail in early February. The 1099’s have gotten much better in the last few years. They now include all cost basis information and all management fees paid, if debited from your account. Your tax preparer will need the 1099 to properly prepare your tax return.
We are here to help answer any financial planning issues. Whether it’s a question about a loan, a mortgage, insurance, or retirement planning.
Should you have any administrative issues, you can always reach out to Kori or Christy, and be assured they will strive to help you in a timely and pleasant manner. Both can be reached using our toll-free phone number at (800) 472-8086.
In Closing
We wish all our clients and friends a happy, healthy, and prosperous 2022. We want you to know that we value and appreciate your business. Thank you for trusting us to manage your financial well-being.
Dan Moskowitz, John Lui and Brian McGeough
