Evaluating the Variables
For investors, there are numerous variables that can impact the trajectory of movements in the financial markets. Among the more traditional variables are monetary policy, fiscal policy, geopolitical risk and economic growth. The past two years have seen an addition to this roster as the coronavirus pandemic and its ensuing policy responses have had a tremendous impact on the U.S. and global economies. For 2021, the annual measure of GDP growth in the U.S. is expected to register an increase of 5.6% according to a survey of economists conducted by Bloomberg. This represents a sea change relative to the 3.4% decline experienced in 2020. Globally, a similar result is expected as the International Monetary Fund currently forecasts final GDP growth of 5.9% for 2021 which follows a decline of 3.1% last year.
For 2022, economic growth is anticipated to continue on a positive trajectory both domestically and internationally. In the United States, GDP is projected to increase by a more modest, but above trend, rate of 3.9% while globally, the growth is currently projected to be 4.9%.
As previously mentioned, there are numerous variables contained in the economic growth equation. There is never a time when these variables can be predicted with complete confidence, but 2022 may prove to be an even more difficult year in terms of anticipating how several of these work out.
First, there is the variability of the coronavirus. As we experienced in 2021, multiple variants can arise. Their pervasiveness led to uncertainty regarding the efficacy of currently prescribed treatment regimens. So far, with the Omicron variant, cases have increased substantially but hospitalizations and
deaths have not. In fact, there is a current belief among some infectious disease experts that we could transition from pandemic to endemic sometime soon. However, should more viral mutations develop, this transition would be delayed and economic growth could be negatively impacted.
The second variable to consider is policy, both fiscal and monetary. On the monetary front, the expectation is that the Federal Reserve (Fed) will begin increasing short term interest rates, specifically the fed funds rate, in 2022. In an initial step to withdraw monetary stimulus, it began tapering its purchases of fixed income securities in November and then at its December meeting announced a doubling of that pace putting it on a schedule to complete the process in March. In regard to rate increases, the dot plot released at the December meeting of the Fed’s Open Market Committee suggests three increases in the fed funds rate in 2022. The dot plot indicates the projections of the Committee’s members as to where rates will be in the future but given our outlook for growth and inflation, we do not currently anticipate three increases will actually be implemented.
Most measures taken to drastically increase fiscal stimulus, to offset pandemic-related economic hardship, have expired. While the prospect for passing the Build Back Better bill is still a possibility, the economic contribution from the bill’s spending provisions will still result in reduced spending at the aggregate level.
The final variable to address is inflation. As has been well documented, the rate of inflation has escalated to a level not seen in several decades. There have been multiple contributors to the increase including supply constraints, pandemic-driven increases in demand for various goods, increasing commodity prices and rising wages. As we migrate through 2022, we anticipate that the rate of inflation will moderate from the current lofty levels. In terms of the supply chain, there is data showing imports are increasing, with evidence that ports are seeing goods offloaded. Also, business inventories have increased for three consecutive months – another sign of easing supply constraints. As for commodity prices, the Goldman Sachs Commodity Index has been essentially flat since hitting a high in late October. And, as previously stated, fiscal spending is anticipated to decline which will also help to lower inflationary pressures.
The Base Case
Given the information provided above, we anticipate the U.S. and global economies will continue to grow in 2022, albeit at a more modest pace than the levels seen in 2020. While consumer spending will continue to contribute to economic growth, business spending is expected to grow at a higher rate. Inflation is expected to moderate over the course of 2022 as the factors that contributed to this year’s increase begin to ease off their recent highs. The monitoring of geopolitical tensions is an area we monitor constantly but is difficult to quantify. With that said, these are our current base economic expectations. As with any forecast, however, constant review and evaluation is required and adjustments may be needed as changes in conditions warrant.
Asset Allocation Review & Outlook
For both the fourth quarter and the overall year, the most aggressive of our five asset allocations delivered the strongest returns. When considering the performance of domestic equities, foreign equities, and fixed income over both the quarter to date and year to date periods, this outcome becomes readily apparent. Domestic equities delivered the strongest performance for both the quarter and the year with the MSCI USA Index up 10.1% for the final three months of 2021 and 27.0% for the twelve-month period. Meanwhile, fixed income was the weakest asset class with a flat return in the fourth quarter and a negative return of -1.5% for the calendar year as measured by the Bloomberg Aggregate Bond Index. Interestingly, this is only the fourth time this index has registered an annual negative return since the index’s inception in 1976.
Currently, we are continuing with the neutral positioning across asset classes for each of our five investment objectives. This positioning is most critical for our balanced objectives that utilize multiple asset classes in funding their mandates. For these allocations, there are several factors that contribute to our neutral positioning. Two of these factors are components of the four tenets of our investment philosophy. At the time of our decision to reduce the level of equity exposure across our balanced allocation objectives, the key driver was our tenet of risk-aware portfolio construction. Valuation levels for equities, specifically domestic equities, were at elevated levels and given our commitment to risk management, a move to a neutral level of exposure was executed.
Another tenet of our investment philosophy is to preserve capital in difficult markets. While 2021 was not a difficult market for equity investors, a number of conflicting themes were ever present during the year. Thus, our belief in the importance of diversification along with the aforementioned emphasis on risk management led to the move to neutral in equity exposure for our balanced objectives. There are numerous historical examples of environments where many investors had extremely high levels of conviction regarding future market movements. And as history has taught us in numerous cases, the higher the level of conviction, the more severe the reversal. The tech bubble of the 1990s is an example.
Our neutral equity positioning is not to be construed as defensive posturing. We do feel however that it is prudent positioning. In closing, we encourage investors to review their current asset allocations to ensure they are aligned with their goals, objectives and risk tolerances.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.