2021 closed another banner year of gains in the stock market: the S&P 500 gained 27%, the DJIA 19%, and the NASDAQ 21%. Bonds? Not so much. US bonds finished the year down 1.6%, not including the effects of rising inflation, which recently rose to a rate of 6.8%, the fastest since 1982. Bitcoin gained over 60%, but not without crashing 50% mid-year. And COVID, in its various mutations, is still very much with us.
So with 2021 now behind us, what’s our outlook for 2022? Let’s say cloudy …. with a chance of meatballs.
Edible weather … and other unknown unknowns
In case you don’t recognize the reference, this delightful children’s movie, adapted from the classic storybook, is about an inventor who develops a machine that turns water into food. Food falls from the sky like rain, thereby saving the town from an economic crisis. Of course, I’m not predicting that meatballs will fall from the sky. My intent here is to emphasize the impossibility of predicting what surprises could present themselves over the next year and beyond. Early in 2021, the economy seemed to be sputtering toward a robust recovery. Then the Delta variant appeared. And then, just as things like travel restrictions were starting to lift and offices were opening up, omicron popped up and started spreading, threatening our health and a return to lockdowns and closures. It seems we (and the economy) just can’t catch a break.
There are many things we simply cannot know or imagine — like raining meatballs — that can affect the economy, our health, and the markets. There are known unknowns, which are the things we know we don’t know, like how long higher inflation will persist, whether and when global supply chains will loosen up, and when employment will get back to pre-pandemic levels. But raining meatballs are unknown unknowns — events and other curveballs that are simply unknowable, but can have a lasting and significant effect nevertheless. The best we can do is make educated guesses based on what we see and know today about the known unknowns.
What the experts predict
A recent survey of Wall Street strategists underscores the challenging task of forecasting markets and economic growth in 2022. Some believe stocks will decline; others see improving corporate earnings lifting market indices, and still others believe there will be a steep correction, followed by a big rally. Over the next ten to 20 years, the forecast for average expected returns ranges from 5.78% to 6.65% for US large cap equities and about 0.50% more for international developed markets. These same firms estimate less than 2% in annual expected returns for US Treasuries.
Forecasts are helpful for setting investor expectations for overall returns — conditional, of course, on various underlying assumptions and caveats. But forecasts are only useful and relevant if they prompt some kind of action or decision. At the end of 2020, experts predicted that stocks would gain 10%, but equities ended up gaining nearly 30%. Average predictions for 2022 are closer to historical averages of 8–10%. Bonds fell 1.6% last year and are expected to have negative returns again this year.
If you’re a trader or a tactical investor and you have conviction in these predictions, you might plow all of your funds into equities and eschew bonds. But if you’re a long-term investor, like we are at Ellevest, what’s predicted to happen over the course of any given year simply doesn't matter. What’s important is having a meaningfully diversified portfolio with investments that can perform regardless of what materializes in 2022.
Keep an eye on these known unknowns
While Ellevest doesn’t manage allocations based on short-term forecasts, we do keep an eye on key factors likely to influence the path of the economic recovery, to better understand any investing implications over the long term.
What are the key known unknowns to watch for?
Inflation
The Fed expects inflation to be more persistent than initially predicted. Experts believe inflation will continue and even rise higher during the first half of 2022, but will then start settling down sometime in the second half of 2022 as supply chains normalize. Medium-term inflation expectations have decreased recently, which supports this view. Investors can observe what the markets are predicting for long-term inflation by looking at the 10-year breakeven rate, the difference in yields between the 10-year US Treasury Bond and Treasury Inflation Protected Securities (TIPS). Currently, the breakeven rate is about 2.38%, which is what the market believes average inflation will be in ten years. Surprise deviations from expectations — such as a decrease in the inflation rate earlier in 2022 or increasing inflation that persists beyond the second half of 2022 — will increase volatility and uncertainty in the markets.
Interest Rates
The Fed has indicated that they will slow their purchases of bonds (ie, dial back their stimulus efforts) and begin raising rates in 2022. The market has already priced in an expected three interest rate hikes in 2022. Any divergence from that expectation — more or fewer increases or accelerated timing —- will again affect the markets.
COVID, omicron, and other mutations
The last 18 months have shown how much we still don’t know about COVID-19 and its effects. If new mutations are discovered — how quickly they spread, how they impact our health, and how effective existing vaccines are in muting their impact — that will dictate the pace of the economic recovery. Previous restrictions on travel, dining, and the return to offices could all be reinstated, thus putting the brakes on an already fragile economic recovery.
All of these factors (and others, like unemployment) are tightly interwoven, and the COVID pandemic is at the center, holding them all firmly in its grip. Without its menacing presence, people would feel safer returning to work and global supply chains could start loosening up, relieving pressure on wages and prices and keeping inflation in check. And if inflation was in check, the Fed might not be so hawkish about raising rates and pulling back on stimulus. The future path of COVID, and how well we manage to live normally with its presence, is the most consequential known unknown, the one that will dictate other risks and future economic growth.
Keep thinking long term
If you are a long-term investor, and your portfolio is well-diversified with asset classes that provide meaningful diversification across multiple market scenarios, what’s predicted for 2022 isn’t relevant. If you've built resiliency into your portfolio, that should include alternative investments expected to perform regardless of how equity and bond markets do, then no action is required, regardless of whose outlook you believe.
Over the long term, however, don’t expect markets to keep repeating the performance we enjoyed in 2021 and 2020. Remember that, historically, equity markets have averaged returns of 9.59% since the Great Depression. Set your return expectations over your investment horizon, and don’t get unnerved if any particular year disappoints (or too confident if it outperforms). Finally, expect a chance of meatballs — those unknown unknowns — throwing a wrench into any well-laid investment plan.
Wishing all our readers a healthy, safe 2022 — and hopes for successful investing ahead.