Investment Commentary

Big Change

By Brian Andrew | Johnson Financial Group • January 13, 2022

4 minute read time

As we begin 2022, we are seeing the action plan for the Federal Reserve as they change course on their low interest rate policy, to get the U.S. economy over the pandemic. This change will have broad reaching impact on the global economy and markets. There’s a lot to consider here. 

Interest Rates

They are headed higher. The Federal Reserve is responsible for setting the Fed Funds rate, an overnight interest rate. The Fed has indicated it will begin to move the Fed Funds rate higher this year. How much higher? Well, the yield on a two-year Treasury bond is a good way to determine just how much the market thinks the Fed might move.

The chart below provides a good indication of the market’s adjustment to the news. You can see that the yield has risen from near 0.25% last fall to the current level of 0.88%.


The chart provides a good indication of the market’s adjustment to the news. You can see that the yield has risen from near 0.25% last fall to the current level of 0.88%.

In contrast, the Fed’s own projection suggests we’ll see 1.6% this year, 2.1% next year and 2.5% over the long run.

Why the difference? The Fed has its own way of projecting where it thinks it’ll be, and market participants have theirs. Since the Fed has almost never been able to execute a policy without adjustment along the way, the market is discounting its future call.

What’s important is that rates will be higher. That’s good news for money market investors, but what about other bond investors? As rates go up, bond prices go down. Because of that inverse relationship, some will say, “If rates are headed higher, then why own bonds?” The answer is that bonds provide both income and important portfolio balance from an overall risk perspective. We have sought to shorten the average maturity of our portfolios and increase their yield. This means that more cash should flow back to our investors each month and can be reinvested at higher rates.

Economy and Inflation

Estimates for U.S. growth in 2022 are above 4%, more than double the pre-pandemic 10-year average. With that kind of buoyant growth, negative impacts of the Fed’s higher interest rate policy should be muted. Yes, higher rates increase the cost of capital—but from a very low starting level. We expect companies will adjust fine.

Inflation remains a concern. However, we expect it to move lower over the year. Some of the inflation in asset prices we’ve seen is due to the Fed providing easy financial conditions. As the Fed tightens, we could see asset prices in some sectors decline.

As we saw last week in the December unemployment report, the labor market has improved dramatically. Unemployment is below 4% for the first time since the pandemic started in 2020. While still not down to the pre-pandemic low, it is moving in the right direction.

Still, the participation rate in the labor force is below where it was in 2019, indicating there are more workers to re-enter the workforce. The elimination of stimulus, the likelihood that the child tax credit does not get renewed and the shift from pandemic to endemic in 2022 will cause improvement in the participation rate.

While the lack of stimulus will reduce consumer spending in the near-term and be an economic drag, we will see income replace stimulus as we move through the year. Higher average hourly earnings rates may produce some price inflation; however, the higher spending that income produces should outweigh any inflationary negative.

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Corporate Earnings

Expected earnings growth for the S&P 500 stock Index is 9.5% for 2022. A big number on top of 2021’s (which we’ll report on when the Q4 earnings season is over). And like earnings, we expect companies to retain high profit margins, albeit not as high as they were in 2021.

The combination of high earnings growth and reasonable profit margins will support the sectors of the stock market that did not participate in the rally of Q2 2020 through Q4 2021.

This chart shows the performance of each sector of the S&P 500 Index over the last five years, with technology on top. You’ll notice that the financial sector, energy and consumer staples are near the bottom.

This chart shows the performance of each sector of the S&P 500 Index over the last five years, with technology on top.

Now look at this chart showing the best performers of the last 3 months. You’ll find consumer staples, financials and energy in the plus column and technology down for the same period.

This chart shows the best performers of the last 3 months. You’ll find consumer staples, financials and energy in the plus column and technology down for the same period.

Over time, market leadership changes with the economic cycle, and we can see this from these charts. So while some say, “You should exit the market at this point,” we believe in portfolio diversification. Our approach is to rebalance, taking gains from the best winners and add to those that have performed less well. Rebalancing should be a regular part of managing the risk of your portfolio.

Closing thought

This year will present challenges for investors as all years do. It will also test all of us as we enter the third year of a pandemic with the fast-moving Omicron variant of the COVID virus tearing through the world. However, we believe we will see the pandemic turn endemic in 2022 along with tighter financial conditions and slower earnings growth. So, yes, slower…but “growth” is still the final word.

This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE