2021 Q4 Commentary
Caution: Turbulence Ahead
Turbulence is defined as the violent or unsteady movement of air or water characterized by chaotic changes in pressure and flow velocity. While 2020 and 2021 were all about fiscal and monetary stimulus and maximum flows into financial markets, this coming year is likely to be quite different. The Federal Reserve (the Fed) has messaged they not only intend to shrink the size of their monthly asset purchases but will also likely begin to raise interest rates AND reduce the size of their balance sheet by selling some of the assets they purchased over the previous 2 years. The Fed believes it needs to take this action to tame inflationary pressures. This reversal of policy will begin to drain the monetary stimulus from the financial markets as we move into the spring and summer months. As market participants wrestle with this changing environment, it seems quite likely both stock and bond prices could experience a fair bit of turbulence/volatility.
But will the Fed be successful in tightening monetary policy? While they should be given credit for aggressively fighting the pandemic induced economic slowdown, their policies may have contributed to inflating asset prices and pulling forward demand. Threading the needle of taming inflation while not unsettling financial markets may be a tough ask. It appears the market has begun to price in 3 interest rate increases for 2022 along with an incremental reduction in the Fed’s balance sheet. This repricing can be seen in some of the highest valuation growth stocks, which have plummeted 20% plus, while banks and financials have surged ahead. Whether this trend continues, only time will tell.
We expect a reduction in both fiscal and monetary stimulus to present a headwind to asset prices in 2022. If history is any guide, it would seem one of the larger risks is a policy mistake by the Fed. Specifically, the Fed proceeds with a significant tightening of financial conditions just as the economy begins to slow and supply chains catch-up. If this were to occur, the Fed would likely have to reverse policy again and begin easing financial conditions later this year. More potential for turbulence ahead.
As we often communicate, our investment discipline is not predicated upon macro forecasts of what the economy or Fed will or won’t do. We concentrate our efforts on researching and owning great companies at a fair price. With the recent correction in stocks, we are growing increasingly optimistic about the future prospective returns of many of our holdings. While there are certainly areas of the market that we believe are still quite expensive, we are also finding more companies trading at reasonable, if not outright cheap prices. It is in times like these that we like to remember the following investing adage. Price is what you pay. Value is what you get.
We appreciate the trust you place in us and remain committed to helping you achieve your financial goals. We wish you and yours a healthy and prosperous 2022.