Celebrating 15 Years of Service

January Newsletter

Jan 15, 2022

The Economy and the Fed

It was a very good year for the economy and the markets in 2021 as we continued the recovery, which began in the third quarter of 2020. The Federal Reserve continued to provide monetary stimulus in an effort to offset the economic contraction due to the pandemic. The monetary stimulus has proved to be very expensive but also successful in supporting all assets including the markets. The $120 billion per month of stimulus continued through November 2021 and is currently set to end by June of 2022 as the Fed has begun to “taper” its asset purchase program. The extraordinary amount of both monetary and fiscal stimulus injected into the economy through increased asset purchases, unemployment benefits, rent and student loan deferments, along with higher labor costs has produced inflation. Increased demand from consumers with cash and reduced supplies, due to the disrupted supply chains, meets the classic definition of inflation; prices rise when there are more dollars chasing fewer goods.

Stock prices which dropped in March 2020 due to the start of the pandemic, have risen to new high levels during 2021. Much of the increased valuation is a result of the extremely low interest rate policy and Fed monetary stimulus. The liquidity must go somewhere, and as a result of Fed and government policy, it went into stocks, bonds and real estate that have all risen to record high levels.

Outlook for 2022

While the Fed is expected to taper down its asset purchase program by June 2022, they are also expected to increase the fed funds rate at least three times during the year (see chart right). This will undoubtedly increase volatility in 2022 as the Fed must grapple with inflation that has proven to be more persistent over the course of 2021 than originally expected. Although some of the inflationary pressures may recede in 2022 from their recent high levels, inflation is still expected to be above the Fed’s stated 2% inflation target level. We expect stronger rental inflation, and continued solid wage growth in the services sector ahead, both key factors in why we expect that inflation will continue to surprise the Fed on the upside. This will continue to disturb the bond market. We estimate the U.S. 10-year Treasury to rise to 2.25% from 1.60% seen at year-end and then reach 3.00% during 2023. Bonds will continue to lose support as the Fed tapers its $120 billion asset purchase program and will face additional headwinds from higher inflation and rising interest rates. To combat these pressures for bond investors, we have shortened our maturities of our bond holdings across the portfolios.

Fed Funds Rate Dot Plot – 3 Hikes Expected in 2022
The Inflation Upside Has Proven Sticky
Rents Warning of Inflation Durability

We continue to favor equities over bonds for their ability to pass along higher inflation expenses of materials and labor through higher prices. We think the economy will expand approximately 5%, in 2022 which is good by historical standards but much lower than the growth seen over the previous two years. We do think equity indexes will be up for the year 2022 but nothing like the returns posted during 2021. Corporate earnings have remained strong despite the economic restrictions from COVID. Earnings estimates for S&P 500 in 2019 were approximately $160 and for 2022 they are estimated to be $220 (Yardeni Research).

Due to elevated asset valuations, there will be more volatility in all asset classes in the year ahead. Cash positions should be used to add to quality equities during market corrections. Cash during the last two years has offered almost no return because of the collapse in interest rates by the Fed. The zero interest rate policies will change during 2022 and we expect cash to again offer some yield, though still not enough to cover the impact of inflation and taxes.

Changes to IRS Tables – Lower RMD’s Possible

New life expectancy tables for calculating required minimum distributions (RMDs) go into effect. The new tables are good news for account holders because they will mean slightly smaller RMDs on account of longer life expectancies. These new tables can be used by anyone who is taking
RMDs, even those who inherited an account.

As an example, the old Uniform lifetime table listed an expectancy factor for a 73-year-old to be 24.7 while the updated Uniform lifetime table now lists an expectancy factor for a 73-year-old as 26.5. The Uniform lifetime table is used by the IRS and most owners of IRAs and qualified The Inflation Upside Has Proven Sticky Rents Warning of Inflation Durability retirement plans to calculate their annual RMDs. The increase in the life expectancy factor from the updated table means a smaller RMD for an account holder.

Estate Planning Tip – Review and Update Beneficiaries

There is a common misunderstanding amongst people that have wills and trusts that the will or trust will override existing beneficiary information on insurance policies, annuities contracts, retirement plans (IRAs, 401k’s, 403b’s etc.) or any other asset that has a designated beneficiary. This is not the case, whomever is the named beneficiary on the policy or retirement plan, regardless of your updated will or trust, will receive the assets.

People get married, divorced, have children and grandchildren, change business partners or decide to exclude certain people from receiving their assets, from example a beneficiary that has enough money when compared to other siblings or family members. There are any number of reasons to review your beneficiaries and your estate plan every few years to ensure it reflects the owner’s wishes.

Tax Reporting Information

The Schwab 1099-Composite reports for tax year 2021, which covers most taxable accounts will be sent in mid to late February. The 1099-R for retirement distributions generally available at the
end of January.

Please note that if you owned foreign securities or real estate partnerships, they tend to report later in March and can be more subject to correction in their reports. Some people like to file their tax return early if they expect a refund, however often there are corrected 1099’s issued and sent to clients. If you can wait until April, you may avoid refiling or having to adjust your return.

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