One of the most consistent bright spots in the market and the economy last year was corporate America’s ability to deliver expanding profit margins even with inflation spiking and specifically with the rising cost of raw materials and higher labor costs. A common question in 2021 was about how the market was able to continue to get higher with all the concerns around COVID, inflation, and the uncertainty around the Fed. Corporate profits was a huge reason why the market was able to continue to go high last year. As you can see in the chart shown in the video for this episode, the net profit margin for companies in the S&P 500 for 2021, was higher than all since 2011. There are two concerns we have going into 2022. One is continued inflationary pressure and the second is a more aggressive Fed. If companies can continue to drive this level of profit growth through pricing power, continue pent up demand, and some help with supply chain issues, then we could continue to see market strength. It’s a simple formula. Higher corporate profits lead to positive earnings reports which, in return, usually, not always, leads to market strength. For that reason, we’re watching corporate profits carefully in 2022.
The Federal Reserve
The Federal Reserve has been a great tailwind for the markets and the economy. It kept interest rates at near zero and provided stimulus by buying 120 billion dollars’ worth of bonds a month. The Fed has already reduced their bond buying and in January there’ll be buying 60 billion dollars’ worth of bonds. That’s still a very large number, but at this rate they’re expected to stop their bond purchases sometime in late winter or early spring. We will get to see, in the next few months, what the market does without that tailwind from the Fed. The next step for the Fed is to raise rates. The reason why that’s very important is that, traditionally, economic expansions don’t just die of old age. Before COVID Australia had a 26-year unstopped expansion. An economy’s growth is typically not stopped due to expansion length but instead, it’s usually killed by the Federal Reserve. The Fed has a terrible track record of taking off stimulus. Between 1955 and 2009, the Fed entered into 14 rate hiking cycles. In 11 of those they had to reverse course because unemployment spiked, and we went to a recession. There are only three times between 1955 and 2009, where the Fed timed things right. That sounds very dire. In 2018 the Fed raised rates and the market had the worst fourth quarter since the great recession. However, we did not enter a recession and that’s because Jerome Powell saw the market trading down and reversed course before the economy weakened. That should give us some strength, knowing that the individual that has been re-nominated to be the Fed chairperson, was one of the very few Fed chair people to have properly orchestrated a rate hiking cycle without pushing us into recession. We have a lot of new Fed nominees coming onto the board so there’s still some uncertainty, but if tradition holds, we may see a rocky 2022-2023. However, if Jerome Powell can replay what he did in 2018-2019, we could see a smooth transition thanks to higher corporate profits.
Unemployment vs. Labor Participation
One thing that Jerome Powell has done, is pay close attention to the job market. That’s one of the few things that are different about him compared to others in his position in the past. With that being said, the monthly jobs report comes out Friday. That’s possibly the most important piece of economic data that we get each month along with the COVID positivity rate. This report will reflect the month of December, which basically will entail the entire month the Omicron COVID variant. In November, we had an unemployment rate of 4.2%. We added only 210,000 new jobs compared to the estimate of 550,000. This will be an interesting report to see how the unemployment rate stands out compared to the Labor participation rate.
Fi Plan Partners is an independent investment firm in Birmingham, AL, serving clients across the nation through financial planning, wealth management and business consulting. Fi Plan Partners creates strategies in the best interest of their clients using both fee based investing and transactional investing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
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