2021 ended on a strong note, with the S&P 500 closing just off its all-time high.  In fact, there were 70 new all-time highs made over the course of 2021.

This note will briefly summarize 2021 and focus on what we believe will be the major themes that will drive the financial markets in 2022, setting the tone for the year ahead.

For 2021, the S&P 500 lead the broad indices with a gain of 28.75%.  The small cap Russell 2000 (IWM) advanced 14.54%, the NASDAQ 100 (QQQ) gained 27.42%, and the international index (EFA) gained 11.46%.  The Aggregate bond index (AGG) declined 1.77% and 7-10 year US Treasuries (IEF) slipped 3.33%.

TWG model portfolios (Growth, Moderate and Conservative) performed in line with their benchmarks, after fees.  We benchmark the model portfolios to a diversified modern portfolio theory (MPT) allocation, which blends the Russell 3000 (97% of the US investable market), the Bloomberg US Universal Index (U.S. Bonds rated either investment grade or high yield with effective maturities between five and ten years) and the MSCI world index ex -US (the other 22 Developed markets) – essentially a passive broad based index-based portfolio, based on MPT, with the same target allocation to stocks and bonds as our model portfolios.  As the S&P 500 never declined more than 5% for the year, we never had to leverage our risk mitigation process (as we did in 2020) which would reduce equity exposure beyond a set drawdown level.

LOOKING AHEAD to 2022

As we look forward in the new year, there are several notable challenges that the market faces, each of which (while not certain) could very well make for a bumpy road ahead.  We believe that the Fed- supported post-COVID expansion has likely run its course, requiring a new set of stimuli to organically expand the economy, but are not suggesting that a recession is imminent.  Instead, in our opinion, gains will be more challenging to achieve this year, and there is a high likelihood that past years of 15% plus advances in the broad markets will take pause.

  1. COVID – Clearly with new mutations and waves arriving one after another, COVID will likely dampen a return to full global economic productivity, given the push and pull effect of disruptions to supply chains, labor challenges, regional (ie: China/Asia) shutdowns, and the like. However, as more of the global population contracts the virus, the less impact it should have moving forward.  This is generally positive but will keep investors concerned.
  2. Biden’s Build Back Better plan – The battle to pass an infrastructure and entitlement bill, which will likely come with increasing taxes on certain segments of the population, has the potential to move the market. This depends on the scope and scale of the re-drafts as investors attempt to position their portfolios if/when this gets passed. However, our belief is that it will be very challenging for a large bill to pass, since it requires Democrats to raise taxes in advance of the mid-term elections.  But the market will be on watch.
  3. Mid Term Elections in November – This can dramatically impact what the administration can accomplish in 2023-24. If we see a GOP wave, then tax hikes will likely be off the table and we will see more gridlock in Washington during the remaining current term — likely resulting in heightened volatility, as uncertainty tends to discomfort financial markets.
  4. Waning Fiscal Stimulus – As the pandemic era stimuli likely winds down in 2022, rising employment and healing supply chains will hopefully offset a reduction in the Fed’s balance sheet and accommodative monetary policy. Again, the pace and rate of changes to the interest rate regime will likely keep investors on their toes as they attempt to get ahead of anticipated rate increases.  This could very well cause dramatic shifts from growth to value (or value to growth) and challenge the effectiveness of bonds ability to maintain historical levels of productivity, appreciation and income generation.  We’ve caught a glimpse of this at times in 2021 as money flows tend to favor high multiple growth names or economically sensitive areas seemingly on a weekly basis, or where rate spikes caused bonds to sell off at times.
  5. Federal Reserve – As the Fed has made it clear of their intent to raise rates multiple times this year, we’ll see if they have the guts to do so. Currently, the consensus view is that we’ll see three .25% rate hikes this year, but if the current administration successfully appoints more dovish Fed members, the future Fed may no longer have the strength to vote on this many rate hikes.  Investors will be watching every minute of every Fed meeting this year and we’ve seen some dramatic reactions in past Fed rate policy meeting days.
  6. Profits – This, in our option, is a big one. Third quarter profits are at all-time highs, still coming off the pandemic year-over-year earnings recession.  Part of the improvement in the profit story has come from government spending (more money to consumers so more money to spend and boost corporate profits).  More jobs, lower unemployment, and higher wages will reduce net profit, but a 10% profit growth is still productive.  If the market got ahead of itself in believing 15%+ profit growth is here to stay, then valuations will need to come in, probably resulting in some overheated areas of the market taking a breather, or worse, declining in value.
  7. China/Taiwan and Russia/Ukraine – In our view these are wildcards that could very well send shockwaves through global financial markets. If there is aggression toward Taiwan or Ukraine, we would not be surprised to see a temporary, and possibly sharp sell off.  However, in our opinion, this will not change the fundamentals, which are strong and should ultimately support higher prices in the future.

So, buckle up, it will likely be a wild ride this year.  The tailwinds will likely abate, reducing the smooth sailing effect of the prior two year’s massive fiscal and monetary stimulus. However, we have the flexibility and tools to adjust as necessary regardless of what may be.  While we never know what “this” is, we will remain vigilant in protecting your profits during pockets of market turmoil, as well as objectively evaluating productive areas of the financial markets to give us the opportunity to seek out further gains.

Stay safe – we wish you well.