The Independent Market Observer

What's Ahead for the Markets and Economy in 2022?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jan 6, 2022 2:32:09 PM

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markets and economyAfter yesterday's monthly looking back/looking ahead post, I had a request to do the same thing for 2021 and 2022. While I haven’t taken this approach in the past, it seemed like a good idea to bring this format to the 2022 outlook in the context of 2021. So, let’s take a closer look.

Looking Back at 2021

A great year? Looking back, 2021 ended up being a great year for both the economy and markets. We started 2021 with the pandemic in full swing, as the second wave was peaking as the year began. The economy had substantially recovered from the first wave, but it looked to be slowing as the second wave progressed. Markets, however, had fully recovered and remained largely stable, indicating that, as far as they were concerned, everything would be fine.

The markets were right. As the year ended, markets turned out to be largely correct. The economy continued to mend, with job growth and consumer spending strong. Companies remained very confident, hiring when they could and investing when they could not hire. And earnings spiked not only in relative terms but in absolute ones, taking markets to a terrific year as valuations largely held—despite fears that rising rates would pull them down.

Looking Forward to 2022

A repeat performance? Looking forward, 2022 looks very much like it might be a repeat—at lower volume—of 2021. As we enter the year, the pandemic is again in full swing, this time with the omicron wave. The economy has continued its recovery, but again we see some weakness as we start the year due to the recent pandemic wave. Markets, however, remain confident and close to all-time highs, suggesting that, as far as they are concerned, everything will be fine. In other words, this is almost exactly the same paragraph as I just wrote for the start of 2021—and there is a reasonable likelihood that the results will be similar. But there will be differences, of course.

What’s different? On the medical front, omicron is much more contagious than prior variants, and case counts are much higher than we saw a year ago. That is even considering the role of vaccinations—the rate of which has largely stalled, leaving large parts of the population unvaccinated. On the economic side, federal stimulus programs, which drove much of last year’s growth, will not help in 2022. And much of the rehiring process appears to have played out, as many people are not moving back into the labor force. Looking back, 2021 benefited from a number of factors, not least of which was starting from a much lower base, that we do not have as we start 2022. Looking forward, though, 2022 has advantages of its own.

Medical risks. On the medical side, case counts are much higher, but the variant itself seems to be less damaging. New vaccinations are down, but the existing vaccinated population is much higher. And for those who do catch the virus, effective treatments are starting to become available, which will limit the damage even more. On top of this, there are signs that the omicron wave may end up being sharper but shorter than prior waves. There are real risks here, but mostly in the shorter term, which could limit the damage even more.

The economy. The same applies to the economy. Yes, the federal stimulus programs are not coming back. But that purchasing power has been more than replaced by something more durable, wage income, as the number of jobs and wages have both increased sharply. The rate of increase may slow, but the base is much higher than a year ago, which provides a firm foundation for continued growth.

Politics and policy. Even on the politics and policy side, 2022 has advantages of its own. Yes, there will be the midterms, which will be disruptive. But the debt ceiling debate has been shelved. Yes, the Fed will be raising rates. But it is doing so because it sees sustained growth ahead, and markets have largely signaled agreement with the proposed course. Looking back, 2021 had its own share of political and policy disruptions, and while 2022 will as well, they will likely be no worse (and quite possibly better) than last year.

The markets. Once again, that is what markets are saying. Earnings are likely to keep increasing as the economy grows. Valuations will likely adjust down somewhat, as rates rise, but this is a normal part of the economic and market cycle and will likely be more than offset by those higher earnings. And all of the other risks (medical, political, international) are risks we have seen and dealt with before.

Smoother Ride in 2022?

Looking back, the start of 2021 was a scary time. But things ended up going well, despite disruption along the way. Looking forward, the start of 2022 is also a scary time, but the likelihood is that we will see similar positive results for the year as a whole.

That said, 2022 will likely not be as strong, especially from a market perspective, as 2021. Last year, we started at a much lower base, both medically and economically, leaving much more room for improvement. Now that we are more recovered, there is less headroom for growth. But as we get closer and closer to normal, we should expect that growth and market returns to normalize as well. 2021 was a rollercoaster year, with a great payoff for that volatility. 2022 may well be a smoother ride, with a consequently more modest—but still positive—result.

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