2021 was a great year for investment portfolios, while also representing a period of increasing wealth inequality as asset prices rose, prices rose, yet wages rose at a much slower pace. People with financial assets benefitting exponentially more than those without.
Here are 3 economic variables that are at the top of our radar that may impact investment portfolio in 2022.
Inflation is an important macroeconomic factor to monitor as it represents general increases in prices and fall in the purchasing value of money on an ongoing basis. Over the last year, consumer prices for goods and services have risen by 6.8%, with fuel, utilities, and vehicles leading the way. Food prices are up 6.1% over the last year. Wages, on the other hand, have only risen by 4.6% over the past 12 months.
Consumer prices are an important measure that helps to frame economic growth. Growth expectations for the US economy are higher this year than in recent history, mainly due to prices rising and supply bottlenecks. Last year, the Federal Reserve removed their controls and language to keep inflation at their target long term inflation rate of 2%. Looking ahead, the Federal Reserve is determining the right level of market interest rates to combat rising inflation. Inflation expectations play a large role in investor behavior – and they are up 15% from last year’s value.
Rising inflation can have a significant impact on all types of investments. Real estate and cryptocurrency could both benefit in an inflationary environment. Further, rising inflation may hurt consumer spending as the prices of goods and services outpaces real wages and the purchasing power of the currencies that consumers own.
Interest rates are the primary determinant to the flow of credit in our economy. Credit helps to fuel economic growth by providing consumers and businesses with additional purchasing power. Benchmark interest rates set by the Federal Reserve bank have a wide-ranging impact on all interest rates including mortgages, student loans, credit cards, and business financing. In March 2020, the Federal Reserve cut their benchmark interest rates to 0.25% from 1.75%. They are signaling a few benchmark interest rate increases in 2022, which may slow the flow of credit and reduce liquidity in the economy. This action has historically slowed down economic growth.
Similar to inflation, interest rates have a material impact on nearly every asset class. US equities had a tremendous year in 2021, as low interest rates helped facilitate high company valuations and ability to borrow cheap debt. Value based sectors like financials, industrials, and energy have historically been compelling sectors during rising interest rate environments. As interest rates rise, bond prices generally fall. As bond maturities increase, they experience more severe price swings as interest rates change.
The US dollar has strengthened over the past year due to a few factors, including rising interest rates. We measure the US dollar’s position versus its international peers, of which drivers are the US trade balance and international interest rate differentials. The US trade balance has increased year over year as a percentage of GDP while international interest rate differentials have fallen.
Looking ahead, there are mixed perspectives relating to the movement of the US dollar. Weakness in the dollar could create an attractive environment for international equities like China and India. Many emerging economies have higher expected long term growth rates than the US and may provide compelling long term investment opportunities.
We believe that 2022 will be an interesting year for each of these variables. We feel that our portfolios and investors need to be selective looking ahead due to our expected changes in these three variables. It will be difficult to find excess returns in broader stock markets.