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Looking Ahead to 2022

Coming off an especially strong year for equity investment returns, it is not unusual for investors to ask “what’s next?” for markets in 2022. There may be no more appropriate answer to that question than the standard investment disclosure of “past performance is no guarantee of future results.” As we have pointed out repeatedly in the past, it is a fool’s errand to try to predict what will occur in investment markets in the short term. We can anticipate some economic and market developments, however, and prepare for the impact on our strategic financial plan.

Inflation to Continue

The economic conditions that brought about rampant inflation in 2021 are unlikely to subside anytime soon. The classic recipe for inflation is too many dollars pursuing too few goods and services. Supply side issues continue to constrain the production and transportation of finished goods and some services to consumers. With so many unfilled job positions across numerous industries the supply side, the supply side of the inflation equation is unlikely to be resolved soon. Compounding the inflation issue is all the money the government has injected into the economy over the past few years. Over that same time period, the savings rate in the United States also increased which means it will likely take some time for the excess cash to be spent. The good news for investors is that there is a weak relationship between inflation and equity returns. As shown in Exhibit 1, in 23 of the past 30 years positive returns occurred in the S&P 500 after adjusting for the impact of inflation, whether the rate of inflation was high or low.
Exhibit 1 - Click to Expand

Increasing Interest Rates

Federal Reserve Chairman Jerome Powell announced in late 2021 that the Federal Reserve would raise interest rates in 2022 in an effort to tame an inflation rate not seen in nearly four decades. Many experts and investors anticipate three and possibly four or more interest rate increases from the Federal Reserve in 2022. There will be multiple effects arising from the anticipated increase in interest rates. One of the obvious impacts will be higher returns for fixed income investors. Over the course of the measured rate increases, yields on fixed income investments will move from historic lows to more familiar rates of return, benefiting investors close to or in retirement. On the other hand, the cost of borrowing money will increase with interest rate hikes. Consumers planning on purchasing a house or vehicle may wish to obtain their loans before the cost of borrowing goes up. Interest rate increases also tend to introduce short-term volatility in equity markets, as more conservative investors sell their stocks to purchase bonds or other fixed income instruments.

Market Volatility Expected

There are a few factors at work that will likely make equity markets more volatile in 2022. As mentioned above, interest rate increases tend to increase equity market volatility as conservative investors trade their equity holdings for “safer” fixed income instruments. The extraordinarily high equity returns earned over the past three years are likely to add to market volatility, as investors lock in these outsized gains by selling off some equities.

Discipline & Diversification are Rewarded Over Time

It is unlikely that equity markets will continue their torrid pace of the past three years indefinitely. But does that mean a market correction is imminent? Regardless of what transpires in investment markets in 2022, there are principles and fundamentals that should always be followed. Disciplined asset allocations, portfolio rebalancing, and focusing on keeping investment costs low are proven strategies that reward investors in the long run. To make sure your financial plan is ready for whatever transpires in 2022, schedule a meeting with Bollin Wealth Management today.

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