Over the past year, equity markets indulged on excess GDP growth, corporate profits and monetary stimulus, paving the way for a steady string of record highs and exceptional returns. We believe 2022 is set up for more economic growth, but at a more modest pace.
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2022 will be a year of moderation, in our view, with the economy and corporate earnings expanding again, but at a more modest pace, while monetary stimulus dials back amid a transition toward higher interest rates. The good news is we think less is more in the year ahead: Fewer extraordinary growth levels and Fed liquidity can still support more bull market gains, accompanied by more volatility along the way.
We see the economy catching a second wind in the latter part of 2022, spurred by healthy consumer financial positions. The personal saving rate averaged 13% over the past year, and labor shortages should support above-average wage growth. Additionally, we expect some supply chain bottlenecks to start clearing in the second half of the year.
Source: FRED.
The above line graph shows the percentage wage growth and personal saving rate in the United States each year from 1996 to 2021. The personal saving rate is calculated as the ratio of personal saving to disposable income. In the United States, wage growth refers to the yearly change in wages and salary disbursements. The chart shows that the personal saving rate hovered between 3% and 12% from 1996 to 2019, before spiking to 34% in 2020. The personal saving rate averaged 13% over the past year. The chart also shows that wages grew more in 2021 than they have year over year since 2008.
A rebound in education, health services and leisure/accommodation employment are likely to drive strong payroll gains in the year ahead. If pandemic conditions improve, more workers are likely to return to work, helping ease labor shortages. However, wage growth could stay elevated through 2022 as the labor force participation rate remains depressed because of increased retirements and other demographic reasons.
Inflation is a key risk for the markets in 2022: We expect it to peak and then moderate while staying above the Federal Reserve’s 2% long-term target. Lingering supply chain bottlenecks are likely to keep consumer prices higher in the first half of the year. But as supply rises to meet demand and year-over-year comparisons become more difficult, inflation will probably cool in the second half.
We expect the Fed to begin raising interest rates in March 2022. While markets have now priced-in four rate hikes, as well as the Fed balance sheet shrinking in the second half of the year, we believe there is room for the Fed to be more accommodative versus expectations, especially as growth slows in the second half of the year.
Ten-year Treasury yields fluctuated in 2021, ranging from 0.9% to 1.7%. We believe yields will move higher toward 2.0% in 2022 and trade in a higher range overall, likely 1.5% to 2.0%. We see this move driven by continued above-trend economic growth and inflation in the U.S., as well as the Fed beginning its rate-hiking cycle.
Source: FactSet.
The above chart shows the U.S. 10-year Treasury yield and real GDP growth year over year from December 2009 to December 2021. The chart shows that the U.S. 10-year Treasury Yield hovered between 0.5% and 4% from 2009 to 2020, and fluctuated in 2021, ranging from 0.9% to 1.7%. Real GDP growth declined sharply in 2020 before rebounding in 2021. Overall, the 10-year Treasury yields trended with real GDP growth pre-pandemic.
In 2022, we believe market volatility will return to more normal levels. Slower growth and reduced liquidity, combined with higher inflation and periods of uncertainty surrounding COVID-19, raise the prospect of a larger market correction in 2022 than we experienced last year. Importantly, however, we don’t believe such a correction will usher in a more severe bear market decline of 20% or more.
While market performance may continue to be positive, we do expect the pace of gains to moderate and volatility to increase broadly. After three years of solid double-digit gains, we see market returns in 2022 more in line with earnings growth, which we expect to be in the single digits.
With a larger fiscal boost, faster vaccine distribution and an earlier easing of restrictions, the U.S. economy reclaimed its pre-pandemic peak in the second quarter of 2021, while European and Japanese activity remains below 2019 levels. We see significant catch-up potential for international markets as overseas economies reopen more fully.
We expect value and cyclical sectors to continue to benefit from above-trend economic and earnings growth, especially in the first half of the year. However, with the Fed dialing back its accommodation and the fiscal stimulus boost fading, the underperforming consumer staples, utilities and health care sectors are likely to hold up better than they did in 2021.
So-called meme stocks, digital collectibles such as nonfungible tokens, special purpose acquisition companies and myriad cryptocurrencies experienced extreme price increases in the past year. We don’t think the highfliers of 2021 are poised to collapse in 2022. In fact, we think risk-taking and cyclically oriented investments can be rewarded as the fundamental foundation of this bull market remains intact. However, we don’t think the gains in these types of speculative investments will be repeated as we advance.
The next phase of the reopening is likely to bring more modest returns and higher volatility, offering opportunities for disciplined investors. We recommend neutral allocations to equities and fixed income, aligned with our strategic (long-term) asset allocation targets of your investment strategy.
We favor economically sensitive international stock asset classes, such as emerging-market stocks and international small- and mid-cap stocks, over large-cap stocks. As interest rates glide higher in the coming months, we believe investors should overweight U.S. investment-grade bonds, which offer higher yields and lower interest rate sensitivity than international bonds.
Our opportunistic (short-term) asset allocation guidance can help you take advantage of opportunities in today’s market without deviating too far from your long-term investment strategy.
Reach out to an Edward Jones financial advisor today if you’d like to discuss your financial strategies in 2022.
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