Stocks rallied to record highs, after Santa Claus and the rally we were waiting for finally showed up. Thanks to COVID news being mostly positive, market optimists fueled the year-end rally with cash from the sideline bringing 2021 to a close with a gain of 26.89%.
Looking back at 2021, it has been an arduous year and the record returns almost makes me forget about the challenges that we not only faced but overcame. Starting the year with the US Capitol Riots, Inflation everywhere, to the rise in Meme Stocks/ NFT (non-fungible tokens), Vaccine rollout to everyone, William Shatner and Space Tourism, the fall/withdrawal of Afghanistan and finally, Covid variants. I am certainly appreciative that 2021 finished on a strong note but as we start 2022, the biggest question that everyone is asking is “where do we go from here?”
To put it simply, I expect 2022 to be another good year. The silver lining in that prediction is that all the gains might come in the second half of the year. As I’ve gathered market insight from many sources over the past several months, trying to get a feel for how stocks will perform, I stumbled upon historical returns during Midterm election years. Interestingly, the data (which I won’t bore you with) shows that since 1938, the market is generally flat for the first six months going into the elections and then rallies hard for the final six months of year. One reasonable explanation for this would be unknown policy implications that could potentially shape/alter the market course for the short term. Now these historical returns are not a guarantee by any stretch of the imagination but when we add in the current issues like surging Covid variants, prolonged supply chain glitches, continued labor shortages, the Federal Reserve ending monetary support by March and then raising interest rates, I can certainly see how 2022 could fall in line with the historical trend. Now whether the turbulence start in January or May remains to be seen. The two key questions that will determine whether stocks can continue the rally, or whether we see a pullback sooner rather than later:
(1) What happens with inflation? (2) What does the Fed do with rates?
The current supply chain issues and labor shortages that we are facing are exacerbating the inflation issue. The longer these exist, the more likely the Fed will try to do something about it and that means hiking rates sooner and more than previously projected. If/When that happens, the market will not respond well to that and the chances of a pullback (0%-10%) are likely and a correction (-10%-20%) is within reason. However, if the Fed can avoid any policy mistakes, there’s a chance that the first half of the year has muted returns before the second half of the year accelerates when they near term issues are all sorted out.