As we enter 2022, the entire PMAM team would like to wish you a healthy and prosperous new year. Despite ongoing challenges posed by the outbreak of new COVID-19 variants and the uncertain timing related to a full reopening of the global economy, we expect U.S. economic growth to remain positive this year, moderating toward the pre-pandemic trend range of 2-3%. The powerful tailwind of government stimulus will decline but private-sector growth will partially fill the void. In particular, consumer spending will continue to benefit from record-high household wealth and strong labor market conditions.
The surge in inflation to levels not witnessed since the early 1980s proved to be the dominant economic story in 2021. Federal Reserve (Fed) Chair Powell was finally forced to acknowledge the depth of the problem by the fourth quarter, implementing an abrupt U-turn in policy (and retiring the word “transitory” in the process). We expect inflation pressures will also moderate this year but remain stubbornly above the Fed’s 2% target. The Fed will follow through on its rapidly evolving plans to remove accommodation with a combination of rate hikes and balance-sheet reduction.
A bullish Treasury yield curve flattening was the immediate market response to the Fed’s “hawkish pivot,” as investors priced in slower economic growth and greater risk of a policy mistake. However, the most recent Fed communication, emphasizing a willingness to shrink its balance sheet more quickly while increasing rates gradually, is likely to keep upward pressure on rates across the yield curve. The Fed is likely to be just as focused on yield curve slope as the overall level of interest rates as it normalizes monetary policy.
Equity markets are likely to face heightened volatility and a steeper hill to climb next year as the Fed pulls back on the excess liquidity. With elevated multiples, higher discount rates and challenging year-over-year earnings comparisons, we expect modestly lower equity valuations by year-end. Equity markets may also be their own worst enemy this year as higher valuations will likely bring on more aggressive Fed tightening.
Credit markets are likely to be more resilient, as strong investor demand for income and low default rates keep spreads range-bound. Duration risk will likely again be the biggest driver of relative performance for fixed-income assets this year.
Exhibit 1. 2020 and 2021 Actual; 2022 and 2023 Forecasts
*1-year as of 3Q21
To read our 2021 market and economic year-in-review, click here.
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S&P 500 Index — An index of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe.
Russell 2000 Index — An index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is comprised of 3,000 of the largest U.S. stocks.
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The views expressed in this material are the views of PMAM through the year ending December 31, 2021, and are subject to change based on market and other conditions. This material contains certain views that may be deemed forward-looking statements. The inclusion of projections or forecasts should not be regarded as an indication that PMAM considers the forecasts to be reliable predictors of future events. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate. Actual results may differ significantly.
Past performance is not indicative of future results. The views expressed do not constitute investment advice and should not be construed as a recommendation to purchase or sell securities. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed. There is no representation or warranty as to the accuracy of the information and PMAM shall have no liability for decisions based upon such information.