2022 Economic Forecast

by John R. Stewart, Senior Financial Advisor/Portfolio Manager | June 15, 2022

You have to go back 50 years to the 1970s to see inflation raging like it is today. Back then we were suffering from an oil embargo, the implementation of LBJ’s domestic spending program called “The Great Society,” funding the Viet Nam War and the Impeachment of Richard Nixon. The inflation saga of the 1970s and 80s ended when Fed Chairman Paul Volker raised interest rates so high that it caused a profoundly serious recession under one term President Jimmy Carter and during the first term of Ronald Reagan.

As we look to 2022, there are negative and positive issues we need to address. Here are the negatives:

Today we are facing inflation rates that many thought we would never see again in our lifetime. How high will it go and how long will it last? Again, government spending and White House and Congressional policy decisions (like stopping oil and gas exploration on federal lands and the elimination of the XL pipeline) are partially to blame. We were an oil exporting nation just twelve short months ago and now we are once again dependent on OPEC for our energy. Also, there is a shortage of truck drivers which has led to supply chain issues. We are dependent on foreign suppliers and manufacturers for most of our products. Inflation is caused by too much money chasing too few goods. Government spending which started in earnest at the start of the Covid pandemic is really getting out of control with the recent passage of the infrastructure bill. The Build Back Better Bill is currently at $2.3 trillion.  A large part of this is offset by tax increases. If all the benefits are made permanent without a tax increase, then the total could be $5 trillion minus current tax increases. Whether this passes in the next couple of weeks appears to be dependent on two Democrat Senators.

So far, The Federal Reserve has been extremely accommodative with very relaxed monetary policy of low interest rates and money supply. However, starting last month, the Fed began tapering the purchase of mortgage backed and treasury bonds which has pumped money into our economy since the 2007-08 great recession. All it will take for the economy to really take a nosedive in 2022 is for interest rates to start to rise to tackle the inflation. Fed officials have maintained that high inflation levels in the U.S. are transitory, and prices should retreat once the distortion of stimulus-induced demand met with COVID restricted supply. Usually when the Fed raises interest rates three times there is an economic slowdown of some magnitude, and we are watching what the Fed does very closely.

Finally, there is a fear that taxes will be increased to pay for all of this government spending.

It is said that the stock market climbs a wall of worry and while there is much to concern us, in 2022 there are many things which are positive.

1. First is the resiliency of capitalism and American businesses. Corporate earnings are what eventually drives the stock market engine and next year should be a great advance of earnings particularly for the larger cap S&P 500 companies. In 2020, the Covid pandemic created the shorted lived recession in our history, and we now have the vaccines available to prevent another shutdown of the economy.The American economy is healthy again and appears to be on a path toward solid growth next year which should be encouraging for U.S. financial markets. Look for GDP to grow in the range of 2.5% to 3%. Estimates for 2022 corporate earnings have moved higher all year. Even during times of higher inflation, stocks and bonds have provided solid returns. It’s mostly at extremes when inflation is above 6% or negative that financial assets have tended to struggle.Look to invest in companies with pricing power to protect profit margins by passing rising costs along to customers. Those in the highest gross margin fields are household products; pharma/biotech; beverages; semiconductors; media; apparel and luxury. Careful security selection and diversification are more important than ever. One potential bright spot for investors in 2022 is that universe of dividend-paying or value stocks. Companies are reinstating dividend payments and some with surplus capital are declaring catch-up dividends.Bottom line for investors: Maintain Balance. Holding a lot of cash has typically been a drag on overall portfolio returns and it may be especially impactful today since real returns from cash are negative.Since 2009, a 60% stock and 40% bond portfolio with rebalancing annually has produced a better rate of return than either a momentum investor purchasing the top returning asset class from the previous year or a value investor who buys the lowest returning asset class.
2. Supply Chain issues should get resolved soon. Many companies are bringing back manufacturing to our shore. The consumer is the main driver of the U.S. economy. There are signs consumers are buying goods earlier than past years to get supplies while they last. Sales in most categories are back above pre-pandemic levels. If the worries and concerns over the supply of goods are greater than the actual scope of the problem, that’s potentially bullish for stocks.
3. Inflation will be tamed one way or the other. The fear of higher inflation might be bigger than the actual risk of higher inflation. If fear outweighs risk, and inflation is even modestly better than most expect, that could be good for stocks.Permanent, nefarious inflation happens when there is too much money chasing too few goods. The U.S. and global economy have the capacity to build-out supply, it is just currently trailing the demand surge in the economy. Bringing supply back online takes much longer than bringing demand back as businesses ramp production and navigate supply chains. Too few goods are flexible, and we believe in a few months’ time more supply will ease inflation.
4. Finally we have to look at the political as well as the fiscal arena particularly with the 2022 Mid-term elections. Historically, elections have insignificant impact on the long-term direction of markets, but they tend to cause some volatility during election years. Stocks tend to have lower average returns and higher volatility for the first several months of midterm election years. As results at the polls become more predictable, this trend often reverses, and markets have tended to return to their normal upward trajectory. But these are just averages, so investors shouldn’t try to time an entry point to the market.If history is a guide the party out of office usually does the best in the mid-term election and if that happens with the House and Senate flipping it could halt the huge spending plans by the Biden administration.

In conclusion, the economy is far from perfect, but demand is strong, the jobs market is wide open, and corporations are posting record profits. Yet few people are happy. Instead, widespread concern and worry over inflation, supply chains, labor shortages, COVID variants are prevailing. That makes us even more bullish. When everyone is fixated on an issue and it becomes widely discussed, its pricing power concurrently falls. This is how “walls of worry” get built, and stocks love to climb them.

This article represents the opinion of John R. Stewart as of June 15, 2022. John R. Stewart is an investment advisor representative with Physicians Wealth Solutions, LLC, a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risks and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discusses herein.