Stocks sold off last week after the Federal Reserve released the minutes of its December meeting, which suggested that the Fed will begin normalizing interest rates sooner than most market participants expected.

While higher levels of volatility could be expected as the Fed moves away from its pandemic-induced and historically easy monetary policy, interest rates are still conducive for increased economic activity.

Importantly, interest rates remain historically low, especially relative to inflation, with the Fed still at the zerobound, while it takes time (6 to 12 months or more) for higher interest rates to work their way through the economy. We also see other important supports for the economy and risk assets as discussed below. While the Omicron surge is disrupting economic activity, we expect this to be temporary (similar to previous waves), with healthy fundamentals supporting a rebound in activity in the coming months.

Outlook for Economic Growth and Earnings Remains Positive: The business cycle and the corresponding profits that it produces are major drivers for stocks. While global growth peaked in 2021, important leading indicators continue to suggest above-trend economic growth should persist in 2022.

Both the service and manufacturing PMIs (timely business surveys) remain in expansionary territory after surging to record highs in 2021. The Bloomberg consensus estimate for developed-world growth stands at 3.9%, well above the OECD’s estimate of trend growth for the G7 of 1.4%. This economic growth is expected to produce earnings growth for the U.S. of 7.5%. After far exceeding original estimates for economic and earnings growth in 2021, we see a good chance that estimates will be exceeded again in 2022.

Significant Remaining Pent-Up Demand: U.S. households are in very good shape with record net worth and over $2 trillion in excess savings. We expect a significant portion of this savings to be spent in the coming years, especially given pandemic-driven pent-up demand.

We also expect further strong spending from corporations, supported by record-high profitability. After several decades of subdued corporate investment, capital goods orders are showing significant improvement. Inventories are also at low levels, which bodes well for further corporate spending.

The housing market should also support growth this year, with both the homeowner vacancy rate and inventory of homes for sale near multi-decade lows. Millennials are in the sweet-spot of their home-buying years and significant pent-up demand remains for housing.

Last Week’s Economic Readings Consistent with Further Growth: The beginning of the month brings important readings from business surveys and the labor market. Last week’s data remains consistent with slower but above-trend, economic growth.

The ISM Services PMI (a timely business survey) showed that services activity lost momentum at yearend, as the fast spread of the Omicron variant held back consumer engagement and delayed some back-to-the-office plans. Nevertheless, excluding 2021, the PMI has been this high only once before, in August 1997, as services activity continues to expand at an above-trend pace.

The ISM Manufacturing PMI saw its second decline in the past three months, and is off its peak reached in March 2021, as factory activity has been weighed down by material and labor shortages. Nevertheless, the index is running above its historical average and above the average during the previous expansion, indicating above- trend growth. Although both the Manufacturing and Services PMIs declined at yearend, their combined latest readings are consistent with 5.0% annual economic growth historically.

While December payroll additions were less than expected, the employment report was consistent with a tight labor market with the unemployment rate at 3.9%, just 0.4 points from its pre-pandemic trough. This indicates the Fed’s criteria of maximum employment and inflation have effectively been achieved, positioning them to normalize interest rates this year, especially given the healthy economic fundamentals we continue to see.


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