You thought the COVID-19 pandemic was scary for investors? Now there’s a whole new world of surreal troubles to navigate…
Stocks and bonds in 401(k)s dropping at a pace not seen in decades.
$100 to fill up your gas tank.
Rising interest rates threatening to trigger a recession just a few years after the last one.
Renowned economist and Bottom Line Personal contributor Allen Sinai, PhD, says dazed investors should take a deep breath—a recession is not imminent. Beneath this chaos lies one of the strongest economies since the 1990s, robust corporate profits, full employment and ample liquidity to support spending. In fact, he believes that higher interest rates and moderating energy prices can bring down inflation enough to keep the more-than-two-year-old economic expansion going beyond the 2024 election and sustain the resumption of a modest bull equity market into 2024. Hugely different is a backdrop of permanently rising interest rates for the first time in decades, causing everyone to review their investment strategies. Here’s what Dr. Sinai sees ahead…
Last year, I explained to Bottom Line Personal readers why inflation—almost nonexistent since 2009—could become a menace. With more than $6.5 trillion in federal fiscal stimulus pumped into the economy and easy monetary policy, American households were on a spending binge. At the same time, factories around the world that were shut down by the pandemic were slow to respond, disrupting shipments of supplies that American companies need to produce goods and services. This imbalance between demand and supply sparked higher prices all around us. Then, this year, two shocks sent inflation to the highest in 40 years and roiled the financial markets, rising into a big negative for stocks. The Fed then let inflation go, and the inflation genie jumped out of the bottle.
Shock #1: The war in Ukraine, and the West’s sanctions and boycotts against Russia, ignited commodity prices. Russia and Ukraine account for roughly one-quarter of global wheat exports. Russia is the third-largest producer of oil, and in the first three months of 2022, oil prices rose about 50%, after rising about 50% the year before in the recovering economy.
Shock #2: The Fed was caught off guard by the velocity of inflation. All through 2021 and the start of 2022, it kept short-term interest rates at near-zero levels, reluctant to remove support for the post-pandemic rebound. Fed Chairman Jerome Powell insisted that higher prices bedeviling consumers were “transitory” and would recede as supply bottlenecks eased.
But by March 2022, inflation was about 8.5% year-over-year…and the Fed announced it would start playing aggressive catch-up to choke off inflation. Interest rate increases slow economic demand by making it expensive to borrow money. In May, the Fed hiked interest rates by 0.5%, the largest increase since 2000…indicated that there would be subsequent 0.5% hikes…and outlined a program to reduce its bond holdings by $95 billion a month. Now short-term interest rates can be expected to hit 2.5% to 2.75% by year-end 2022 and 3.75% to 4% by year-end 2023. This change has led to uncertainty in the financial markets. Higher bond yields push down bond prices, which make safe investments such as US Treasuries far riskier. And since many investors are no longer willing to pay a premium for the expected future profits of fast-growing companies, the high-flying tech stocks that everyone owns have imploded.
Some constraining of the economy is desirable, allowing it to chug ahead at a more sustainable rate. But if the Fed slams on the brakes forcefully, it could precipitate a bear equity market and a deep recession. I’m reasonably confident that won’t happen. The economy can withstand higher interest rates without crashing in the next few years, thanks to employers continuing to hire, rising wage growth and consumers’ willingness to travel, eat out and purchase vehicles and homes. Families are in better shape today than they were before the 2007–09 Great Recession when plunging home prices and high debts ruined households’ finances.
Caveat: The Fed’s ability to pull off a soft landing is complicated by three geopolitical wildcards…
War in Ukraine. I am assuming the war will not get worse…that global energy supplies can recover from the shock…and that oil prices will ease back.
Misguided legislation from Washington, DC. The economy does not need any more stimulative aid. Republicans are likely to retake control of Congress in the November elections, so the prospects of legislative gridlock would be a positive for the stock market. But the incendiary issue of abortion rights in the US Supreme Court could energize Democratic and female voters this fall and change the calculus of the midterm elections.
China’s zero-tolerance COVID-19 policy has led to the lockdown of citizens and businesses in Shanghai and Beijing, increasing global-supply bottlenecks. I expect China’s estimated 2022 Gross Domestic Product (GDP) to be 3% and estimate global growth at 2.5%. By 2023, as the lockdowns fade, I see China’s GDP increasing 5% and global GDP 4%.
Here’s what I expect for the rest of the year and beyond…
GDP: I’m forecasting real GDP to grow 3.8% in 2022 and 3% to 3.5% in 2023, supported mainly by strong consumer and business spending.
Unemployment: The jobless rate should continue to drop and reach the low 3s this year—the lowest level since the mid-1950s. By the end of 2023, though, the red-hot job market will slow in response to a slowing economy and the rate should be in excess of 4%, still quite low but able to ease inflation. A tight labor market will boost average wage growth to 6.5% in 2022 and 7% in 2023.
Inflation: As measured by the Consumer Price Index, inflation will moderate by the end of 2022 to 5.5%, down from 8.5% in March, and continue to fall, reaching 4% by the end of 2023.
Although the stock market is fairly valued now after a steep correction between January and May, I expect it to rally enough to eke out small gains by year-end. I’m forecasting the S&P 500 and the Dow Jones Industrial Average to return about 2% to 3% for 2022, including dividends. This comeback will be driven by solid corporate earnings as companies pass along higher prices to consumers. Earnings growth should rise 9% in 2022 and another 7% to 8% in 2023.
Best sectors for the rest of 2022…
Health care. Despite inflation, consumers will seek out more care and elective procedures. A more health-conscious aging population will add to demand.
Consumer staples. These steady, mature companies perform well during periods of robust economic growth and rising interest rates. They are able to raise prices for consumers, improving profit margins and earnings growth.
Financials. Higher interest rates create billions in additional annual revenue for banks, which pay low yields on deposit accounts while lending out at higher rates.
Avoid…
Energy stocks—they’ve had an enormous run in the past year, making their valuations less attractive. Swings in oil prices make them vulnerable to volatility.
Stocks of FAANG companies—Meta (formerly Facebook), Alphabet, Amazon, Netflix, Google—and other large-cap tech firms with exorbitant price-to-earnings ratios.
I expect yields on 10-year US Treasuries to spike as high as 3.7% by year-end 2022 and 4.5% by year-end 2023. The severe bear market in bonds is not going to let up. For seniors, attractive fixed-income options are short-term US Treasuries, top-quality corporates and muni bonds held to maturity so you get guaranteed return on principal. A 12-month US Treasury bond recently paid 2.01%…a two-year Treasury, 2.47%—far better than CDs and deposit accounts. Even shorter-duration bonds will do, with yields pushed up by Fed tightening. And when your Treasury bonds mature, you’ll be able to reinvest the cash in new Treasuries with even higher yields.
