LPL RESEARCH PRESENTS outlook 2022- From Hand Up to Hand Off

By Celeste Orozco | January 19, 2022 |

The U.S. economy bounced back from its worst year since the Great Depression in 2020 with one of the best years of growth in nearly 40 years in 2021.

A combination of record stimulus, a healthy consumer, an accommodative Federal Reserve (Fed), vaccinations, and reopening of businesses all contributed to a big year in 2021. In what amounted to the shortest recession on record, only two months in March and April 2020, the economy came roaring back to produce what is currently expected to be over 5% GDP growth in 2021, more than making up for the 3.4% drop in GDP in 2020. Of course, there have been hiccups along the way. You can’t shut down a $20 trillion economy and then expect it to get going again without warming up first. Supply chain backlogs, materials and labor shortages, and higher prices all held the economy back to varying degrees. The good news is, demand is still very strong, and as the backlogs unwind (which could take years in some cases), we expect above-trend economic growth and see low risk of a recession in 2022. With various measures of output matching or exceeding pre-pandemic levels, it’s clear last year’s recession is in the rearview mirror, and it may go down as the shortest one in history—even shorter than the six-month recession from the early 1980s. As the U.S. economy moves more to mid-cycle our 2022 forecast is for 4.0–4.5% GDP growth in 2022 [Fig.1]. While a slowdown from 2021, it’s still a very solid number. We expect inflation to tame from 2021 levels to a little above 3.0% with core inflation numbers lower, a step in the right direction, although it may still be on an upward trajectory the early part of the year. Globally, Europe and Japan were hit especially hard by the pandemic in 2021. But as COVID-19 cases potentially fall globally, those areas could be ripe for better economic growth in 2022. Meanwhile, emerging market economies may disappoint as growth in China could be constrained by regulatory crackdowns.

Keys to the handoff

Fiscal and monetary policies played big roles in the economic recovery in 2021, but we see 2022 playing out as a handoff—from stimulus bridging a pandemic recovery to an economy growing firmly on its own, with consumers, productivity, small businesses, and capital investment all playing parts in the next stage of economic growth. You have to give the U.S. consumer credit for continuing to drive the economy forward, and 2022 shouldn’t change that. Don’t forget, it took retail sales only five months to get back to pre-COVID-19 levels after the lockdowns in March and April 2020. Bottlenecks and the Delta variant surge have done little to slow an eager consumer. With likely still low interest rates, increased equity in people’s homes, nearly $3 trillion in money markets (retail and institutional), and another $3.5 trillion in excess liquidity in bank accounts, the consumer should remain quite healthy in 2022. Like every other time in history, those who adapt will survive. Businesses have already started to adapt to the new world, which may help productivity increase in 2022, as efficiency gains flow through to economic output. Productivity allows for stronger growth and can help contain inflation, since more goods and services are produced. The 1970s was known as a time of high inflation, but it was also a time of very low productivity—fortunately a scenario we don’t see happening this time around. Another key to the economic transition may be capital expenditures (capex). These include business investment in property, plants, buildings, technology, and equipment. These investments could boost overall productivity and overall output, but might take time to build, so the results could be years away in some cases. Additional capex spending would be one of the best ways to see if corporate America is indeed over the shock of the pandemic and ready to invest for future growth opportunities. Standard and Poor’s data shows capital expenditures are expected to have grown an impressive 13% in 2021 and likely even more in 2022. In fact, the capex rebound in this recovery has already been faster than previous downturns, with plenty of room to go in our view. And it isn’t just a U.S. theme, as 2021 was likely the best year for European capex since 2006, and the global chip shortage has led to major investments in Japan and South Korea as well.

The everything shortage

2021 was the year nearly everything was in a shortage, and it all translated to added inflationary pressure. Record numbers of ships waiting at ports, a lack of materials, unfilled job openings, higher commodity prices, a lack of truck drivers, major backlogs, and supply chain disruptions all added to the larger price increases seen essentially across the board in 2021.

While we do believe these pressures will steadily decrease over the next year and inflation will eventually settle back to 2–2.5%, it will likely be a gradual process. Inflation remains near its historic run rate after removing the most volatile, pandemic-influenced prices [Fig.2]. This more stable measure of inflation has historically tended to pull broader readings of inflation towards it over time. Still, supply chains may take a year or two to be fully addressed, depending on the product and the scale of the problem. Despite challenges around supply chains, hiring, and prices, if the demand is there it should help drive continued improvement as businesses adapt to address challenges. That is likely to leave us with a positive economic backdrop for at least 2022, and maybe much longer, despite current inflation levels.

How much time is left?

Let’s face it, this wasn’t your average recession. Some industries actually did better during the pandemic, while segments of other industries were severely constrained. Spending patterns shifted. Stimulus was delivered quickly on a massive scale. How strange did that make it? This was the first recession in history that saw FICO scores go up. Recessions are necessary to wash out the excesses, but some imbalances weren’t worked off this time around. For this reason, we think this economic expansion could be mid-cycle much sooner and likely won’t be as long as the record 10 years we saw last cycle. The average expansion since World War II has been just over five years, suggesting there are still potentially several years of growth remaining, especially since we don’t see typical recessionary warning signals right now. Far from it, we anticipate above-trend growth in 2022. But we’ll be on watch early.

Check back in with alternative investments

With bond yields low and prospects of modestly rising rates, it may be an appropriate time to check back in with alternative investment strategies (alts), especially those that have historically acted as a way to diversify interest rate–related fixed income risk without simply adding stock-like exposure. These strategies include global macro, multi-strategy, equity market neutral, and our preferred solution—event driven. While these strategies all have their own characteristics, they’ve historically provided a risk/return profile similar to that of core fixed income, while having limited exposure to equity market movement. In contrast to core fixed income allocations, which struggle to play their traditional defensive role during periods of rising rates, these strategies may help protect portfolios in the current environment and act as a source of ballast. Event-driven strategies generally seek to profit from the outcome of specific corporate transactions such as mergers and acquisitions, significant changes in capital structure, spin-offs, or even bankruptcies. There are three main macroeconomic tailwinds that may help support event-driven strategies in 2022: high corporate cash balances, low borrowing rates, and the private equity industry’s dry powder. Of late, these tailwinds have helped drive merger and acquisition volume to near all-time highs. A robust deal flow environment like this allows event-driven strategies to be more selective in choosing underlying transactions and also moderates position crowding within the industry. Risks associated with event-driven strategies include the negative price impact from transactions failing, regulatory risk, and the potential impact of changes in the tax landscape.

Commodities and currencies may fall out of sync

One surprise in 2021 was that it saw both commodities and the U.S. dollar advance significantly. Typically, commodities and the dollar move in opposite directions, and commodities’ ability to climb higher—despite the dollar headwind—highlights the strength of their move in our view. While we don’t expect this same dynamic to continue into 2022, we remain positive on industrial metals like copper and expect continued gains. However, we are more neutral on precious metals like gold and silver, which have stagnated over the past year and would likely be hurt by rising real (inflation-adjusted) interest rates. The near-term technical trend of the dollar is positive, but we see less upside than in 2021, and 2022 may be a year of muted dollar movement. Higher interest rates in the U.S. than other major developed economies may continue to drive dollar flows, but that may potentially be offset by the longer-term negative impact of the trade deficit and expanding government debt levels. Finally, oil prices surged significantly in the past year, pushing above $80/barrel for the first time since 2014. We see limited near-term upside for oil prices after such a strong rally along with rising risk of increased supply.

This research material was prepared by LPL Financial LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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Not Bank/Credit Union Guaranteed

Not Bank/Credit Union Deposits or Obligations

May Lose Value

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