2022 Economic Outlook

(Dan Hassey is a great analyst understanding and analyzing the economy. We decided to open a new section to publish his findings and analysis of the economy for informational and educational purposes.)

The forecasts, estimates, outlooks are summaries of 2022 outlooks from Barron’s, Wall Street Journal (WSJ), Fortune, BusinessWeek, Charles Schwab, Merrill Lynch, Goldman Sachs, UCLA, University of California Riverside, Truist (SunTrust), Invesco, Fidelity, podcasts from several prominent investment firms, analysts, and my analysis of economic, business, and investment trends. Some of the forecasts below are from WSJ surveys of over 60 economists from Wall Street, academia, and corporate America. Predicting the future is extremely difficult, if not impossible. It is helpful to follow these forecasts to determine if they are improving, stabilizing, or contracting. Updated forecasts and trends are essential to follow, so I do Quarterly Economic Updates and Monthly Market Outlooks. The markets change much more than the economy.

Many economists and analysts agree that we must solve the pandemic health crisis for the U.S. and global economy to recover fully. We start this outlook focusing on the pandemic, especially in the U.S.

COVID 19 

Here is a slide from UCLA’s Economic Outlook. Covid has been and will be the dominant influence over the global markets and economy.

To quote UCLA’s Economic Outlook, “Next two quarters have a higher degree of uncertainty than usual.”  

Investors and economists don’t have experience investing in disruptions from a pandemic. This makes life and investing more complex than past economic and market cycles.

Here are the latest trends for covid in the U.S.

We have had several waves of infections. The latest from Omicron has caused infections to soar, but worse are deaths, about 2,000 a day. We are close to one million dead in the U.S. since March 2020. Very sad.

Omicron is highly contagious. 8.8 million workers called in sick in early January, a record. Even though it’s not causing as many deaths as past waves, more people are getting sick, overwhelming our healthcare system, especially healthcare workers. Burn-out among healthcare workers is now common.

You do not want to wind up in a hospital with more patients and fewer healthcare workers, and ICU bed occupancy the highest since late 2020. 

The U.S. has probably seen the worst of covid, but the mutations are occurring in poor countries that don’t have enough vaccines and healthcare infrastructure to get covid under control. Because the world is mobile, covid mutations have spread quickly and globally. No one knows when and how this pandemic will end. The rest of the world is not of the woods for covid. Here in the U.S., people are getting covid fatigue and are letting their guard down. This means covid will probably be with us for a while, and we will have to learn how to live with it.

The impact on the economy and markets have been profound: we had a deep but short-lived recession thanks to all the aid, support, and stimulus money from the Fed and lawmakers; we had a short bear market; massive layoffs; supply chain disruptions; inflation; uncertainty…

China & Covid

Covid started in China. China is a global manufacturer of many products, parts, ingredients that the U.S. and world need. Their covid zero-tolerance and lockdown policies are creating global supply chain disruptions. They also have energy shortages that have closed some businesses. An example of how extreme their lockdown policies are is Shanghai Disneyland. It was shut down for two days after a visitor tested positive. According to British media, all the 34,000 visitors and staff had to be tested before anyone could leave.

Health experts are concerned about the Winter Olympics being hosted by China. China has little herd immunity because of its zero-tolerance/lockdown policies. Making things worse is their own, developed vaccines are not effective. The Omicron variant is highly contagious. Because of China’s low herd immunity and all the visitors flying in and out of China, the potential increase in infections could cause significant global health and economic problems (more lockdowns, more supply chain disruptions). Let’s hope these health experts are wrong. 

China’s growth is slowing, and this will impact global growth and prospects. 

Supply chain disruptions are part of the inflation increase. Many businesses are working on solutions to minimize supply disruptions now and especially in the future. Click here for a link from the WSJ that explains some of these strategies and moves. An improvement in supply chain problems is one of the reasons why inflation is seen going down in the future.

Inflation (CPI), & Interest Rates

Because inflation is a concern of investors, economists, consumers, businesses, the Fed… My outlook for the 2022 economy will start with inflation.

Below are the inflation consensus forecasts from the WSJ survey:

The forecast for inflation a year ago for 2022 was 2.22%. It is now almost 1% higher at 3.11%. According to the survey, inflation should drop below 3% next year.

I did write a special report on inflation. Below are some excerpts from the report:

Causes

There are many causes of the inflation the world is experiencing. Below is a summary of the main reasons for current inflation trends.

Covid

Covid is the leading cause of inflation. The global economy basically shut down because of covid. In the U.S., the Fed created trillions of liquidities to avoid a deep recession. Lawmakers provided cash to workers, businesses, and other organizations to help them get to the other side of the pandemic. The global economy was unprepared for the strong pent-up demand backed by liquidity and lots of cash in consumers’ pockets. 

We avoided a deep recession, but now we have an inflation problem that the Fed usually handles.

Supply Chain Bottlenecks and Shortages

Covid is also responsible for the many global supply chain bottlenecks. It is also causing shortages from food to semiconductors.  

Labor

Labor shortages were a problem before the pandemic and will probably be a problem for the foreseeable future. Low-wage jobs are the hardest to fill. Also, certain skilled positions aren’t being filled because of a skills gap.

The baby boomer retirement trend accelerated during the pandemic. Retired baby boomers are probably not coming back to the labor force.

Energy

Lowering energy costs could be a longer-term problem. A shift toward electric vehicles, shareholders, focus on their return of capital, and ESG (Environmental, Social, and Governance investing) will probably mean less capital for energy. We will probably also see less drilling.” 

The Federal Reserve and Inflation

Below is my favorite chart because it explains the main influences of our economy: inflation, interest rates, economic cycles  

Let’s study this important chart:

• The red trend line is inflation. Notice that when inflation goes up, the Fed raises rates, the blue trend line.

• The Fed raises rates to slow the economy and inflationary pressures. The economy usually slows down, then the cycle’s economic sins (normally bad lending and capital allocation) are revealed. The slowdown often turns into a recession (the gray shaded areas). 
  Normally, the Fed lowers rates during a recession to stimulate the economy, and the economic cycle starts again.

• Notice that the cycles before 1980 were shorter and numerous. Also, notice the inflation trend went up, from around 2% to over 12.5%. In 1979 congress passed the Humphrey-Hawkins Full Employment Act” that gave the Federal Reserve the responsibility to create economic conditions for full employment AND stable prices (fight deflation or inflation).
  The leading causes of the inflation of the 1970s include: Arab oil embargo of ’73,’74, the Iranian Revolution in 1979, and poor monetary policies.

• The Fed is getting better at controlling inflation and economic cycles. Notice after 1979, the inflation trend was headed down, and the economic cycles were longer. As the chart shows, the Fed has been successful in controlling inflation and the economy.

•  We almost had deflation three times (in 2009, 2015, 2020, see chart below).

The Fed got lots of criticism when it started raising rates at the end of 2015. It started reversing the rise in 2019. We did go into recession in 2020, but it was not due to rising rates, the cause – covid.

The Fed had issued statements in 2020 that they would keep interest rates low probably until 2024. The reasons for the low-interest rates: 1. To stimulate the economy that was in a deep recession. 2. inflation had been under control for so long (see chart below) 3. So many people lost their jobs during the lockdown, so the Fed stated they would leave interest rates low until most people who wanted a job could get a job. This made sense at the time.

Here is an inflation chart for the last dozen years:

From 2011 to 2021, inflation was basically below 2%. We currently have a surge in inflation.

Many of us professional investors have seen the success of the Fed controlling inflation over many cycles, so we were not too concerned. We now have high inflation, and we are basically at full employment. Many of us are worried that the Fed has not started raising rates and has not stopped buying treasuries and reducing its balance sheet. They will probably begin raising rates in March versus now.

The Fed has a tough job of raising rates and lowering its balance sheet to slow the economy and inflationary pressures but not push the economy into a recession.

Consumers and seniors need to remember that most of us have had risen in our incomes. The increase was about 6% for Social Security beneficiaries, and inflation will probably be about the same, almost a wash. The chart below shows the wage increase for different workers:

The biggest wage increases went where it’s needed, the lowest wage earners. 

We have a problem with inflation, but the alternative may have been a long, deep recession.

As the table from the WSJ suggests, most economists believe that inflation will cool. Some of the reasons include: the Fed will raise rates to slow the economy and inflation, supply chain disruptions will ease (click on link in Covid, China section), the economy will slow this year (see end of GDP Is Expected to Slow….section.)

Labor and energy costs will probably remain elevated. I write about labor in the Employment section below. I briefly discuss energy in the excerpt section above. Better yet, read my Special Inflation report.

Interest Rates

In grad school (MBA UCLA), we learned about macroeconomics that includes inflation and interest rates. We were told that investors want to be paid at least the inflation rate to protect the purchasing power of their investment dollar.

The chart below shows that before the Great Recession and the popping of the real estate bubble, the Fed lowered rates to stimulate the economy to essentially zero percent. For about the last dozen years, investors have not been paid enough to lend out their money as represented by the 10-year Treasury. 

The premium above inflation goes back decades, and the chart only goes back to 1990. If we look at the above chart before 2008, investors were paid between 2% to 5% premium above inflation. If inflation falls to 3%, then the 10-year should be about 6% (3% inflation plus 3% premium average of premium over inflation).

One of the many reasons the Fed was raising rates from 2015 – 2018 was to normalize rates, in other words paying investors at least the inflation rate. Other reasons include raising rates that could be lowered in case of a financial crisis (good thing they did because it helped stabilize the financial markets), President Trump’s tax cuts caused the economy, and inflationary pressures to accelerate. 

Economists, investors, businesspeople know the Fed has to raise interest rates. Here is WSJ survey regarding the Fed funds rate:

According to the survey, the Fed funds rate is expected to rise to almost 2% by 2024. If inflation falls to 2% as forecasted by the WSJ survey, then rates will be close to normalization. 

GDP

The Wall Street Journal surveys over 60 economists from around the world once a quarter and asks their forecasts for the economy, inflation, interest rates, employment: Here are the latest 

Forecasts for GDP:

Again, the forecast surveys are done once a quarter. The second column shows the dates of the forecasts. Growth forecasts have been between 3.58% and 6.89%. 

The economy has momentum from 2021 and is enough to help the U.S. achieve about 3% growth in 2022. 

Because consumers and investors are focused on inflation, they are missing how strong our economy is. 4th quarter 2021 GDP numbers came out recently (see chart below), and GDP grew a robust 6.9%, above forecasts. Growth for 2021 is about 5.3%, way above the historical average. 

Consumer spending and capital expenditures are strong and are above pre-pandemic levels.  

If you ask millennials or baby boomers, both will say they are more interested in spending on experiences (travel, eating out, going to concerts, spending time with family and friends…). Covid has reduced the ability of people to have these experiences. Below is a chart that shows how spending on goods is above pre-pandemic levels, but spending on services remains below pre-pandemic levels.  

The economy could have a fuller, more robust recovery once covid is under control and consumers can enjoy the service sector and its experiences. 

GDP Is Forecasted to Slow This Year and Next

Some of the reasons include:

• Stimulus and support from the Fed and lawmakers are winding down. 

• The economy is like running a 5K. It’s normal for the economy/race to start fast but then slow as the cycle/race continues. Also, growth comparisons get harder to beat.

• We have about a $20 trillion economy, the largest in the world. The law of large numbers suggests that it will be hard to move the growth needle with an economy this large.

The omicron virus is expected to slow the U.S. and global economies. The IMF recently lowered their growth forecast for the U.S. and global economy. 

My biggest concern is a black or gray swan event (low probability but high impact event) that occurs before the Fed can raise rates and clean up its balance sheet. The Fed is key to keeping the recovery going, getting inflation down, and preparing for any black or gray swan events.

The Fed starts to raise rates normally toward the end of a cycle when inflationary pressures build. Then, a recession usually starts because of economic and business mistakes made during the economic cycle (see the Fed funds, inflation, and recession chart on page 3.) 

Below is a focused chart on the rise and fall of Fed funds rate from 2015 to 2021:

Will we go into recession because the Fed is raising rates? No one knows for sure. But notice the chart on page 3, the inflationary pressures build toward the end of a cycle, and the mistakes of the cycle start to be revealed. There is not enough time in this cycle for capital allocations/ bank lending to go bad; we’re too early in the cycle. We may escape a recession. 

Employment

The labor picture is mixed. Just about anyone who wants a job can get one (the right skills are needed for higher-paying jobs). We are basically at full employment (4% unemployment is considered full employment). There are more job openings than people looking for work.

Below is the WSJ survey for unemployment:

Again, as the chart below shows, there are plenty of jobs available, more than pre-pandemic levels.

Women have been slower to return to work.

One of the main reasons given for the low participation rate for women is childcare availability.

 

Childcare providers are having problems retaining and attracting employees. 

There is a high burn-out rate among many workers. Below is a chart of the quit rate among U.S. workers:

The highest quit rates are with jobs that are low paying, variable hours, little job security, and benefits.

There are other reasons for the high quit and lower participation rate:  baby boomers retiring; some workers have started their own businesses; some are concerned about getting the virus and spreading it to family members…; because there are more workers than jobs; some workers don’t have the right skills for this economy. 

Labor costs could remain elevated. I write about it in my Special Inflation report. Click the link in the inflation section, or email me, and I can email you the original word doc.

Consumer

Consumer sentiment has been dropping. 

The causes for lower consumer confidence include: covid fatigue, inflation, political divisiveness, the media tends to focus on the many adverse economic and geopolitical problems the U.S. faces... Good news doesn’t sell.

We can see retail sales declining in most categories:

Economists point to lower consumer confidence and slower retail sales as signs that the economy is cooling. The slower economy could ease inflationary pressures.

Geopolitical Concerns and Other Gray Swan Events

Black and gray swan events are low probability but high impact events. Gray swan events have happened before, and there is experience in handling these events. Examples include wars, climate change events (hurricanes, floods, droughts…)

When covid first started, I thought it was a gray swan event because we’ve had many pandemics for the last few decades, but nothing like covid. I now consider covid a black swan event because of its insidiousness and global impact. 

We have been dealing with geopolitical tensions for decades, especially from Russia, Iran, North Korea, and now China. We’ve had two wars (Gulf War I, II) over the last 30 years, and both led to recessions. China’s assertiveness towards Hong Kong and Taiwan is causing concerns among world leaders. 

The biggest threat to peace and the global economy is the Russian/Ukrainian crisis. This situation is too big an issue for me to analyze the economic impact here. Investors should keep an eye on this as I will. Also, I’m an investment expert, not a military or diplomacy expert. 

Conclusion and Summary

The economy has enough momentum to have a good 2022. The economy will probably slow back to pre-pandemic levels later this year and as this economic cycle continues. 

But there are many headwinds that the global economy and investors face:

• Covid

Investors, businesses, consumers, leaders, economists… have never had to deal with a pandemic this far-reaching. Covid has been the driver of the global economy (recessions, global supply chain disruptions, inflation, layoffs, lockdowns) and will continue to be. Investors must keep an eye on covid, especially global developments and mutations. The WSJ keeps close track of covid developments. Below is their link.

Coronavirus Tracker - WSJ

• Inflation
  Most economists believe that supply (supply chains improve) and demand (slowing economy) should move to equilibrium later this year.

• Rising interest rates
  The potential for mistakes by central bankers (raising rates too fast or slow, reducing balance sheets, chocking off the current economic expansion), especially here in the U.S. 
  The employment picture is mixed: we are basically at full employment, and anyone who wants a job can get one. But, there is a high quit rate, and many job openings are going unfilled.

• Geopolitical tensions, especially between Russia and Ukraine 

Sometimes investing is like taking a familiar road trip. Even though the trip is familiar, a lot can go wrong: weather, car breakdown, traffic, detours, road construction… This investing cycle would probably be similar to the markets of 2016 to 2018, the last time the Fed raised rates. 

2018 was a good time to trade stocks and the markets. But, because of the increased risks of war between Russia and Ukraine, the Fed raising rates, covid – it probably makes sense to have a higher level of cash, as much as 10 to 15%. More on my investment/trading strategies in my next market update. It should be out toward the end of the month.

 

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed, produced and edited by McIntosh Capital Advisors, Inc. to provide information on a topic that may be of interest. Copyright 2022 Dan Hassey at McIntosh Capital Advisors, Inc.