This first newsletter of 2022 not only addresses four financial themes to watch in 2022 (including one about dogs of the market) but also explores COVID and inflationary pressures while reminding you of three determinants of stock prices.
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COVID and Inflationary Pressures
Unfortunately, COVID is still with us as we start 2022. We all have been dealing with this pandemic for two years. A new year brings new possibilities and we hope we will not be writing about COVID in 2023.
Like us humans, the markets and the economy have been dealing with COVID too. As vaccination and therapies were developed we all began to stir, resuming consumption and increasing demand for goods and services.
While aggregate demand returned, the effects of COVID on the workforce did not allow for a commensurate supply response. The result is price inflation for goods and services.
While we all seem shocked at the higher grocery and fuel bills, inflation did not appear overnight. Asset prices have been rising steadily and significantly for some time. Housing, stocks, cryptocurrency, art, and wine have been booming.
While COVID kept us from spending on stuff, money flowed into all sorts of assets. Once we could start spending again, prices for our everyday items took off. This is ushering in a different dynamic.
After the financial crisis, there were strong deflationary pressures that caused Central Banks to take “extraordinary” measures to try to raise prices and promote growth. Now, inflationary pressures are in the system and Central Banks are signaling a reverse in policy and a desire to move towards “normalization”.
This means higher interest rates.
Three Stock Price Determinants
An inflection in policy will likely create turbulence in the markets. Three important factors that determine stock prices are interest rates, company profits, and investor sentiment.
The Fed has signaled that interest rates will go higher. All things being equal, this should depress equity prices.
If we see COVID moving to a more manageable illness, company earnings should grow as consumers spend. In 2021, the government passed an infrastructure bill that should also support demand. A strong earnings environment can offset the downward pressure higher rates place on the stock market.
If investors believe that “normalization” is good, that too could help support stocks. After all, if the Fed is not going to “normalize” now, then when?
Four Financial Themes to Watch in 2022
There will be a few themes I’ll be following in 2022.
High-Flying E-commerce and Internet Stocks
The first is whether the Fed has popped the bubble of the high-flying e-commerce and internet stocks. The announced change in Fed policy seems to have sparked a re-valuation in the stocks that trade at very high multiples. Many companies lost a lot of market cap in the 4th quarter of 2021 and the slide is still going on and may continue. Valuation has a habit of catching up to investors.
Bouncing Dogs of the Market
The second theme to watch is whether some beaten-down stocks in 4Q21 will bounce back to become winners in 2022 – a sort of “Dogs of the Market”.
Many stocks that suffered at the end of last year were not high flyers with crazy high valuations. Did tax-loss selling and momentum algorithms create overly sold shares of good businesses?
A lot of very solid companies with real business models saw their stock prices tumble 20-30% from their highs – think fintech, renewable energy. Do these moves reflect a correction that is only a pause in long-term uptrends?
If you look at the charts of Amazon and other winners, you notice they experienced significant declines along the way to higher and higher prices.
Third, will inflationary pressures ease as 2022 unfolds?
The market seems to have moved away from the view that inflation is “transitory”. Is it possible that some aspects like supply bottlenecks will yet prove to be solvable?
The answer will depend on the path of COVID and the ability of firms to increase production. If prices do not ease, the Fed will need to continue its tightening path which will be a headwind for asset prices.
The last theme to keep an eye on is “re-shoring”.
In 2020 and 2021 the relationship with China changed significantly. A feeling that manufacturing needs to return to the US and Europe could present opportunities for investors. Capital may flow to firms that are re-engineering the supply chains in key sectors like semiconductors, solar panels, and mining.
This commentary has a lot of question marks but investors should be able to follow events and economic data. The art will be in how investors position themselves.
It’s always important to be responsive to changes and to create robust portfolios to manage risks.
Thanks for reading.
>> Download the January 2022 Newsletter <<
Image credit: White Dog 1649 by Wenceslaus Hollar (Bohemian, 1607-1677) after Adriaen Jacobz Matham (Dutch, 1599-1660). Art Institute of Chicago
Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. Investing involves risk.