He who lives by the crystal ball will eat shattered glass. – Ray Dalio
Thankfully, 2021 proved to be slightly more predictable than 2020; however, after the onset of a global pandemic, the bar was set particularly low. In reflecting upon 2021, and where the markets and the economy are today, below are two of my predictions for 2022. As the Dalio quote alludes to, while one may become rich going all-in on their convictions about the future, they may just as easily become poor.
1. Federal Reserve Underestimates Inflation
Thankfully, the Federal Reserve has retired the term ‘transitory’ when referring to the current inflationary environment; however, up until now the Fed has been slow to react and indications from the December meeting did little to show that this behavior would change moving forward. While the scripted portion of Powell’s press conference was rather uneventful, the post-statement questions were perhaps a bit more telling. Steve Liesman from CNBC asked a rather astute question, inquiring as to whether the Fed should be looking to wrap up its asset purchases sooner in order to more aggressively raise interest rates in 2022 to deal with inflation (given the timing lag between policy change and impact to the actual economy)? Powell proffered a ‘non-answer’ in response, but did express concerns about stopping too soon. His response sounded a bit like the tail wagging the dog, which may keep equities rising higher in the short-term, but ultimately may allow the inflation problem to exacerbate, damning returns in the medium-term. With supply-chains under continued pressure, and China’s resolve to maintain a zero tolerance COVID policy despite the new and highly contagious variant, supply-side inflation may very well last long enough to transition into demand-side inflation, which as the 70’s/80’s showed us is a bit harder to put back into the box.
2. S&P Closes 2022 Lower Weighed Down By Tech
As of today, over a quarter of the S&P 500’s holdings are in Information Technology stocks, with Apple, Microsoft, and Amazon alone comprising over 15% of the index’s value. The sector with the next highest weighting, Healthcare, comprises only 13%. The index’s composition poses a concern on two fronts. One – inflationary environments inevitably come with rising interest rates, which disproportionately hurt high growth stocks, such as tech. Two – President Biden has made it clear that part of his agenda is to reign in Big Tech. While nothing has been able to rattle the market to-date, Biden’s policies will likely mean fewer acquisitions from Big Tech in 2022, which will hinder future growth prospects (and thus current valuations). The S&P has risen over 40% from its pre-pandemic level with its price-to-earnings ratio increasing 20% over the same period, meaning half of the valuation growth has come from real financial performance, while the remainder is from multiple inflation driven by hopes of future growth. Valuations are teetering on the edge, which means any bad news may cause an immediate sell-off. Pairing lofty valuations with high concentration is a bad combination, whether we’re in an inflationary environment or not.
