2021 Market Review and Look Ahead

This is my usual year-end review of the financial markets and economy as well as a look toward 2022 and what that will look like for investors.

Another Year of Pandemic

Image of arrow going upward

2021 turned out to be another year dominated by the pandemic and news related to it.  During the year the US economy opened back up for business as the number of Covid cases dropped and it became safer to go out and socialize again.  The vaccine was made available prior to my estimate of end of 1H2021, and President Biden pushed for it to be available to all by the end of May.  This vaccine was what a large portion of the population was waiting for, and the number of people getting vaccinated soared in the early part of the year.  However, this stalled partway through the year as a vocal anti-vaccination voice made itself known and too many people listened to those reports which were full of misinformation.

In addition to the pandemic news, other geopolitical issues drove the market this year. Whether it was the threat of China taking over everything, taking over Taiwan, or Russia rattling the cage that it would invade Ukraine, this led to uncertainty. Surprisingly, the market did not choose to make any of those events to be the start of a pullback or a recession but would just bounce back again.

This year also saw a lot of new money entering the market (starting in 2020) from retail online brokerage platforms.  We also saw the increase of prices, but the economists were unsure whether this was a temporary increase due to supply shortages, or if it was a long-term inflation due to the injection of too much money into the economy.  The hope was that it was temporary because it was approaching a 10% inflation rate, which hadn’t been seen since before Paul Volker was the Fed chairman and pulled in the high inflation rate in the 1970s.

It was this year that I heard about an alternative to the classical monetary theory in which borrowing causes inflation and a large country debt results in inflation.  The alternative is known as Modern Monetary Theory (MMT)and says that when a country has full control of its own money (as opposed to being tied to some other country’s money or to something like a metal) there are different rules for inflation.

Inflation – is it Lasting or Temporary?

In this theory, a country can generate money and spend it to by goods and services as long as there is a surplus of those goods and services.  However, once the government creates more money than can be satisfied by the output of the companies providing those goods and services, then it causes a supply shortage and prices go up, causing inflation.  As long as the government is not buying up too much of the corporate output, it can continue to create money and increase the debt without causing inflation.

So, the question is whether by the MMT, are the supply shortages we are seeing due to the government spending too much for goods (indirectly) than was available for supply?  I say indirectly because the government created money and put it in the hands of the population as cash.  On the whole, the population has used this to buy things putting pressure on the supply side by increasing demand.  An interesting question (that we cannot yet answer) is when the money has been spent, and no more new money is coming from the government, will the demand drop off and supply rise again and bring the supply-demand equation back into balance?  I have read articles indicating that if the purchasing goes back to a more normal level, it could take anywhere from a year to several years for the supply to catch back up again.

Looking at The Markets

As I am writing this on the last day of 2021, the market is looking to have around a 25% gain for the year.  The NASDAQ is looking even better.  There were a few pullbacks along the way during the year with the largest one coming in September and October.  This was driven by the increase in Covid cases due to the Delta variant with the fear that the low vaccination rate would result in overflowing hospitals again.  Would states have to shut things down again?  The uncertainty resulted in this pullback.

The other pullback was in December because of the geopolitical situations with China and Russia.  In addition, a new variant, Omicron, spread like crazy as it doubled cases every 3 days in Great Britain for a while.  As we end the year, the Covid cases are spiking again nearly to the level of December 2020 and in the mid-Atlantic region, hospitals are beyond capacity again.

Curiously, the market has shrugged off these events and continues in an upward trend with the three major indices ending the year just below all-time high levels.

What Will 2022 Bring?

As you know from earlier entries, I don’t make specific predictions on the market.  I have been reading economists who are saying that the market may be rather flat over the next few years and that volatility will increase again.  I happen to agree with them.  There are several knobs that are being turned that will slow down the markets upward drift.

First, the fed has started to slow their injection of funds into the economy with plans to start to raise the overnight interest rates in 2022.  The 20-year treasury bond has dropped in price to bring the yield near 2% after being around 1.5% earlier in the year.  Stock prices have risen more than can be sustained by the underlying company financials, resulting in very high price to earnings ratios (P/E ratio).  At some point, we will return to where we were at the end of 2019 where stock prices needed to drop or stay flat in order to allow company earnings to catch up to the valuations of the stocks.  With the reduction in government money coming into the economy I predict that this will result in these flat or even a pullback (up to 10%-20%) in the coming year.

The number of retail investors who are on trading apps are affecting the market as well.  But these new investors have never seen a pull-back or a recession and so they will be shaken out as their always-up investing methods will fail them.  This will result in a lot of “I’m out”, putting more pressure to the downside.  I also see institutional investors taking profits, although they tend to need to keep fully invested and so that appears as a rotation of sectors/industries.

I cannot leave this view of the future without mentioning what I think may be the next Black Swan.  That is the country of China.  This country has been expanding its footprint, investments, and influence far beyond its borders for some years now.  It now has “hooks” in quite a number of countries in Africa, South America and the USA.  In fact, the supply chain problems we’ve had this year are significantly due to the fact that a large portion of goods purchased by the USA are manufactured in China.  A lot of our tech gear is manufactured there.

What this means to me is that China could get to a point (if it hasn’t already) that it would be able to take over a number of countries without having to go to war to acquire them.  As an example, if China decided to stop all exports to the USA, the country would be crippled for quite a number of years.  Instead of the USA calling the shots on what would happen, China would decide when we would get access to goods.  They could cause a collapse of our economy and be able to come in peacefully as the new power.  I don’t predict that this will happen in 2022.  But this is a very constant, quiet, trend that has been happening for many years and I do predict that this trend will continue.

Changes in Sectors

I believe that we will see sector rotation in 2021 and with the forecasts being for a lower return on investments this coming year, it will probably be a rotation into value based stocks (that pay a dividend) as well as into more defensive areas such as utilities, real estate (through REITS), and consumer staples.  The FAANG stocks have gone up more than the market in general and it appears that they are due for a pull-back.  Some have already pulled back from their highs in 2021.

Conclusion

I look forward to see what we have in store in 2022.  I predict both an optimism that we can move beyond a worldwide pandemic, and that this will provide an opportunity for other aspects of the economy to take over again.  Things like stock pricing being based more on company earnings than other non-financial drivers.  Geopolitics will take a more visible role in driving world economies.  And the rules I’ve learned over the past few decades may return to play allowing less risky investing.

Posted in Finance.