During 2021, the U.S. economy continued to improve after last year’s contraction, taking the stock market along for the ride. Stocks benefited from the growing economy, low interest rates, and strong corporate earnings. The bond market gave back some of their gains from 2020 as interest rates rose from levels near zero. The stock market is ending the year at record highs, which is interesting given some serious issues that we are dealing with as an economy. Rising inflation, the ongoing pandemic, a shortage of workers, and supply chain problems are among the issues that could derail economic growth in the new year.
As we write this letter, the Omicron variant is racing around the globe, causing new restrictions, and lowering economic growth estimates for the first quarter of next year. As long as this pandemic lasts, it will be a threat, not only to human health, but to economic health as well. The last truly global pandemic was so long ago that it is impossible to draw any parallels about how our economy will recover as the pandemic persists.
During the last decade, inflation has averaged just 1.8% per year, the lowest average for a decade since the 1930’s. We talked a year ago about the Federal Reserve changing their mandate to keep inflation low and made the decision to allow inflation to rise, so higher inflation shouldn’t be a surprise to anyone. However, several things combined to let inflation get higher than the Fed wanted. Supply chains damaged during the pandemic have been slower to recover than product demand. American workers have left the workforce in large numbers, with 3.2 million Americans retiring in 2020, an increase of 56% over an average year. The Fed has kept interest rates low to keep the economic recovery going, which also adds to inflationary pressures.
Since 1960, inflation has been higher than 5% twelve different years, most recently in 1990. The stock market rose in six of those years, but with an average gain of just 3.2%. High inflation is even worse for the bond market, pushing interest rates higher and bond prices lower. High inflation makes it much harder for investors to make money.
As we make our economic and market forecasts for the upcoming year, there are many factors that could go either way, leading to dramatically different outcomes. If the pandemic ends, we would expect stronger economic growth, higher interest rates, low bond returns, and continued good stock returns. If the pandemic gets worse, we could see lower interest rates, a strong bond market, and disappointing stock returns. Inflation, likewise, will lead to different outcomes if it continues to rise versus dropping. Our crystal ball is definitely very cloudy this year leading us to remain risk neutral for the foreseeable future.
As always, we appreciate your confidence in Wabash Capital. Please contact us if you need anything, or if you would like an updated copy of our Form ADV.