In the February issue of our monthly flagship publication, we feature:
- On the Record by Chief Investment Officer Tony Roth shines a spotlight on inflation—maybe the single-greatest and most unpredictable determinant of how the economy and markets will unfold this year. He presents his team’s base case for demand, supply chains, and productivity, along with the potential for upside (commodity prices, wage pressures, housing) and downside (consumer slowdown and weaker return to services) risks to that base case. Portfolios are, therefore, positioned for any outcome, and defensive assets are poised to serve as a healthy offense.
- In Focus allows you to find out how much you know about our 2022 outlook. For fun, education, and in preparation for your next portfolio review, take a brief quiz to be in the loop on our economic and investment expectations for 2022. Then, touch base with your advisor to see how your portfolio may need to be reevaluated in light of those insights. Are you ready?
- Investment positioning and municipals asset class overview
Investing is challenging because, like many disciplines, it requires predictions and analysis of myriad variables. However, today’s environment is unusual in that the path forward for the economy and financial markets is likely to be dictated by a single factor: the trajectory of inflation. Of course, other data points, such as labor market statistics, manufacturing data, and consumer activity, require attention. However, with the economy essentially at full employment, the purpose of these indicators is principally to gain clues about future inflation and, in turn, monetary policy.
What makes today’s environment challenging is handicapping a wide range of potential inflationary scenarios that could result in a similarly wide range of financial market outcomes. As evidence, the Bloomberg inflation forecast survey of 51 Wall Street economists—as measured by Consumer Price Index year over year (CPI y/y)— for the fourth quarter of 2022 ranges from 1.7% to 5.4%. On one end of the spectrum, inflation could decline precipitously, providing the Federal Reserve considerable breathing room in tightening policy and extending the economic cycle well beyond 2023. At the other extreme, the Fed might need to tighten policy so aggressively that it induces a recession by late this year. In this letter, we detail our expected forecast—for inflation to decline to around 3% on the CPI y/y by end 2022—as well as identify where we could be wrong to the upside and, yes, even to the downside. (The January CPI data will be released the day after this issue is published; while the numbers could move in either direction, they will likely not change our assessment of the trajectory for the year.)
Our base case
What we consider most likely to occur hinges on expectations of slowing demand and easing of supply constraints, as well as an appreciation for the impacts of productivity and base effects (the latter referring to the simple mathematics of higher inflation readings from 2021 rolling out of the calculation and bringing down the y/y rate).
- Demand—Consumer spending, particularly for goods, has been an important driver of higher inflation. Going forward, we expect it to slow as the fiscal stimulus that inflated savings rates— including the most recent Child Tax Credit sent out each month in the second half of 2021—moves into the rearview mirror and savings levels normalize. If COVID-19 continues to wane allowing consumers to more comfortably spend on services, further pressure will be released from goods spending. We have already seen some slowing of consumer activity, with inflation-adjusted spending on goods contracting in the fourth quarter of 2021. The much-awaited rotation from goods into services is happening but with less fire power given the dwindling of consumer savings and rolling waves of viral variants.
As the old adage goes, high prices can be the best cure for high prices. We are witnessing price increases at the gas pump, food store, auto dealership, and elsewhere dent consumer sentiment and appetite. The categories of retail sales that fell the most in December are those that have had the biggest price jumps. We expect this dynamic to further play into a moderating of demand in 2022 as prices are unlikely to decrease even if the rate of inflation declines.
- Supply chains—The 2021 surge in consumer goods purchases, coupled with COVID-related worker shortages and port shutdowns, resulted in massive disruptions to global supply chains and subsequent spikes in input and transportation costs. (See our 2022 Capital Markets Forecast for more on this topic.) Data indicate some potential signs of relief for supply chains, but the picture is mixed at best. The ISM Manufacturing PMI has shown improvements in inventory levels, supplier delivery times, and input prices. Global measures show similar easing overseas. At the same time, hundreds of ships are still sitting idle off the West Coast, and an aggregated measure of global supply-chain pressure from the New York Federal Reserve shows an Omicron-induced spike back to all-time high levels of stress.
Nonetheless, looking forward supply-chain pressure should ease considerably by mid-2022 as goods purchases slow and virus-related disruptions recede, taking shipping costs and broader inflation with it. Supply-chain pressures, as well as wage pressures, will also ease if some or all of the 1.8 million people currently citing the virus as a reason for not looking for work return to the labor force.
- Productivity—We have talked for years about the importance of productivity, and it is central to the inflation conversation. Technology is a disinflationary sector of the economy. Not only do technology prices tend to decrease over time as computing efficiency increases, but the integration of technology into virtually every business makes firms markedly more productive. Technology is a key reason why the U.S. economy has grown to 3% above pre-pandemic levels with 1.7 million fewer workers.
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