Why Does the Beginning of 2022 Feel Different?

Financial Planning

Let’s face it, 2022 has had a rocky start. We’ve seen a lot of selling, a lot of volatility, and rebalancing among asset classes during these first few weeks of the year. Much of this change is attributed to expectations around inflation and what steps the Fed will take in response. Throw into this mix, the earnings season, which started a couple weeks ago, and you have the perfect storm. One thing the markets dislike more than bad news is uncertainty, and January 2022 held a lot of uncertainty for many investors.

Turn on any news station and you will see doom-and-gloom headlines. So, let’s look at some of the positive potential for 2022.

What is happening with the Fed?

Now that we are two-thirds of the way through S&P 500 earnings reports, and the Fed has had its first meeting for the year, there is less uncertainty today than there was Jan. 1, and we are starting to see the market find its footing. Looking at the markets going forward, nearly 80% of companies that have reported so far have beat earnings and revenue relative to their own expectations and, because of that, the underlying earnings piece of the stock market has improved while the overall price of the stock market has declined. As we sit here today, the stock market represents a much better value than it did six weeks ago. The overall earnings of the market looking forward is around 19x P/E, whereas going into the year, it was above 20x P/E. Being invested today has a better cushion than being invested six weeks ago.

The next Fed meeting will occur in March, where many analysts are expecting the Fed to increase rates 25 to 50 basis points.

Should I feel nervous about Inflation?

The annual inflation rate for the United States was 7.5% for the 12 months ending January 2022 – the highest since June 1982, according to U.S. Labor Department data. The important thing to note is that 43% of that inflation number is housing costs and 33% of that number is your mortgage payment or rent.

While the headline was “annual inflation rate is 7%”, a third of this 7% figure (if you own your home and have a fixed rate mortgage), has not changed. It has possibly even improved since a year ago. People worry they must be making an additional 7% to keep up with inflation. The reality is, if you own your own home and you refinanced in the last year, your feeling of inflation was probably more like 3-4%.

But 7% inflation can be scary – food prices have gone up, gas prices have gone up, but a huge component of this inflation number is your housing cost, which may not have increased and, for some people, maybe have even declined because of refinancing.

This is why using a tax-smart approach when it comes to your finances is imperative. Being careful about where we allocate capital during financial planning and making sure we take advantage of refinancing mortgages when it makes sense can make a large difference during tumultuous or uncertain markets.

Going forward, inflation expectations for 2022, are in the mid 2% to 3% range and 40% of that is housing. You should not be scared about your daily costs going up 1-3% because 1-3% is not a crazy number. Recently, everyone has been anxious because it is the first time we have seen inflation above 2% in well over a decade and it just feels weird. Think about it this way – you are sitting in traffic on the freeway going 40 mph for the last dozen years and suddenly, the freeway opens, and you are going 70 mph again. This is the speed you are supposed to go when on a highway, but it’s scary because you haven’t known anything else but a slower pace for a while. Remember, inflation is a component of GDP, so this means the world is growing. Growth is a good thing and is an indicator the world is doing better.

Some additional good news is the end of inflation-fueling supply chain issues may be on the horizon. Maersk, the shipping company, is responsible for about 1/5th of all overseas transportation in the world. They have announced they expect supply chain issues to start to ease before the end of 2022. This puts a huge relief on the inflation pressures we have been feeling.

What about Bonds?

Bond prices have gone down year to date because interest rates have increased. Again, we may be slightly offsides here. Ivan Gruhl, Chief Investment Officer for Avantax, calls bonds “a self-healing asset class” so while prices will dip temporarily while rates increase, the nice part is we are able to start buying bonds that are paying a higher interest rate than before. With time, that higher interest will add the return back to your portfolio. We want bonds paying higher interest, though it may just be a little uncomfortable to get from where we are today to where we ideally want to be. This is a good thing if we look at the long-term picture. But in the short-term, you might experience negative returns in your bond portfolio, which you haven’t seen for a while. Take comfort that this is all part of the process – you must learn to be comfortable with being uncomfortable in the short-term.

Since March of 2020, pretty much every monthly statement you’ve seen has been positive or close to flat and so we experience a recency bias which is just a normal human phenomenon. We must actively train ourselves that before we open the statement, “The number on this statement could be up or could be down.” Sometimes, the number is going to be negative, but that doesn’t mean your plan is destroyed.

What if you are retiring now?

If things are getting more expensive and you are on a fixed income, that could be concerning because you don’t have anything to hedge out those inflation increase costs. But most people have some inflation as part of their overall financial picture. Social Security has an inflation component, some pensions have an inflation component and if you are drawing from stock and bond accounts, historically, investing in equities has been the best single way to combat the rising costs of inflation over time. The challenge is that it can be very volatile, and you can experience drawdowns, so you must have a plan in place to combat this over time.

So, if you have a portion of your overall portfolio invested in equities, over time, they should continue to outpace inflation. It is important to balance your portfolio and have enough less volatile stuff to draw on in retirement: cash, bonds and annuities, that are stable and predictable because the stock markets will go through bouts of volatility. It’s important to have both types of assets in your portfolio. But if you have stocks to help you with inflation over time and lower volatility assets to help you during times of volatility, then you generally have a well-balanced plan. This is something we stress test for in our in our financial planning software. If we have already done financial planning with you and you are worried about the impacts of inflation or rising rates, have us run a stress test. If we’ve already built your financial plan, it takes less than 10 minutes. If you haven’t built a financial plan, reach out to us. We are happy to build a financial plan for you and stress test your financial portfolio.

Many things in the world are like a pendulum, they don’t stop at perfect. They swing through both ways. Right now, it seems like most people’s expectations are for inflation to continue at a rampant pace and for the Fed to have to be hyper-aggressive in their interest rate increases. There are still unknowns, but I feel like we may be at a peak or near it. I encourage you to put blinders on for the next eight months. If you do, you may find that you wake up in calmer waters than you’re in today.

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