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2022 Market Outlook: Predictably Unpredictable

Published on January 3, 2022

Peter Mallouk
President & CEO
Jonathan Clements Headshot

Jonathan Clements
Director of Financial Education

As we enter a new year, Peter Mallouk and Jonathan Clements discuss what risks could await investors in the year ahead – inflation, market volatility, and overconfidence – and why having an investment plan that’s based on your needs is key to weathering the unknown. Plus, they offer a reminder to proactively monitor your portfolio taxes and identify opportunities to harvest losses throughout the year.

Listen to Peter’s and Jonathan’s recap of 2021

Learn more about tax-loss harvesting

Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!

Have questions or topic suggestions? 

Email us @ podcasts@creativeplanning.com


Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education for Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Another year is in the books. Stocks are up, bonds are down, inflation rose, the Fed reversed course, and cryptocurrencies did pretty much everything imaginable.

Along the way we all expanded our financial vocabulary, adding phrases like meme stock, SPAC, and non-fungible token (NFT). So what does 2022 hold? Here at Creative Planning, we aren’t in the prediction business. We are in the business of managing risk. Today’s topic: What risks await investors in the year ahead? Today’s topic number one: inflation. The last report for the Consumer Price Index put it at 6.8% for the past 12 months. Peter, for investors in stocks and bonds, how big a risk is inflation? And who do you think it’s a bigger issue for: bond investors or stock investors?

Peter Mallouk: What’s interesting, [Thomas] Hoenig was with the Federal Reserve, actually out of Kansas City, had a very long article about his thoughts around this in USA Today last week. It was fairly ominous. He really views the Fed as having really overreached with the way it flooded the system with money and lowered rates far longer than he felt was necessary. The point of the Fed is to interfere, to manipulate the economy, to help propel us out of problems so that we have modest inflation. They want there to be modest inflation, around 2%, and they want there to be full employment, meaning most people are working, 96% of people are working.

Well, we have those things, yet we still have very intense spending at very, very low rates. His concern is as they begin to unwind this, and as they begin to do things to take money out of the system and raise rates, that the bubble won’t lightly diffuse, instead it may pop. There are people on the other side that think that doesn’t matter what the Fed does, that there’s so much technological innovation controlling prices. People being replaced by artificial intelligence in many ways that it kind of doesn’t matter what the Fed does. The answer is no one knows; we’ve never done this before. We’ve never had a situation with this much spending coupled with this low of rates, which is why you have very diverse opinions.

We have a couple facts. We know that when you keep interest rates very low, it inflates asset values because if interest rates are low, the same monthly payment, you can pay more for a house. You can pay more for a business. You can pay more for commercial real estate. We also know when there’s more money chasing the same amount of things, prices go up. So we know what the Fed is doing is inflationary, there’s no question about that. We know with technology and innovation that that does control inflation somewhat. If everybody needs to have a higher wage, but some of those people are replaced by artificial intelligence whether it’s in the finance industry or McDonald’s, it does put a control on prices. What we don’t have is the perfect recipe of how these two things work together. This is brand new. The only thing we can expect is… as we have been, to be surprised and for it to be very, very bumpy.

And this is why, as we talk about predictions today, it should always come back to the investor’s plan. That’s what we’re going to end today with, because no matter how much conviction you hear people talk about both sides of this; to me, conviction means you don’t really know the issue very well because it’s just got too many variables.

Jonathan: So, when we think about bond investors and inflation, and we know every increase in the inflation rate is a pure loss for bond investors. If you’re getting $10,000 in interest every year and inflation rises 5% or 6%, that’s a dead loss and you’re not going to make that money back. For stock investors, it’s more uncertain. We don’t know how stock investors will react to the inflation that we have in the year ahead in these steps that the Fed has taken. The Fed is told us what it’s going to do. It is told us it’s going to taper bond purchases. It’s told us that there will be increases in short-term interest rates. So if somebody believes the market is reasonably efficient, I would assume that the market has already priced this in, but maybe not. What do you think, Peter?

Peter: I think the market’s priced in both sides of this issue, but we don’t have clarity yet. So I think the way to think about this is, let’s assume that there was a very high probability risk of, of an attack. The market would price it in, but every hour that goes by the odds go up or down of the attack until eventually one happens or doesn’t happen. The market’s not perfectly efficient until the very last second. Right? So I think that the bond market and the stock market are telling us different things. The stock market’s saying, “Hey, look, prices are going up and the businesses are passing on the prices to consumers, and this is working great.” So the stock market goes up to reflect the built-in inflation.

The bond market seems to be telling us, it’s not convinced that there’s going to be very high interest rates. People are perfectly comfortable loaning money to the Federal Government for 10 years at 1.501%. It would not be doing that if they thought interest rates were going to be 4% in a year or two from now. So I think that there’s just so much money in the system that it’s not as discerning as it would normally be. We don’t really have the clarity. We don’t have any clarity around how this will play out.

Jonathan: It’s been an extraordinary two years, Peter, with the pandemic, but the result has been two extraordinary years in the stock market. We had stocks, as measured by the S&P 500, up 16% in 2020, they were up more than 20% in 2021. A lot of people are saying this year, 2022, is going to be a normal year, which might mean 7% or 8% returns. It’s hard to think that actually having a gain would be considered a danger. Yet, it also seems that a lot of people have very high expectations for what they’re going to get from the stock market in the years ahead. Do you see that as a risk for investors?

Peter: It’s interesting when you hear about “a normal year,” because while the stock market historically is… it depends on what time period you want to pick, it’s averaged 9%, 10% or so. It never earns that. In Creative Planning, when we’re doing projections, we always tell our clients, “Hey, the returns we’re using here, the odds that the market’s going to get this in any particular year very close to zero, right?” The market tends to be up over 5% or down more than 5%. Most of years returns tend to be quite variable. So I think a normal year would be for it to be a double-digit return or a significant loss. I think that what’s missing in all of this when we look at predictions… And I’m just going to go back to, I always like to look the Barron’s top 10 strategist predictions at the end of the year.

If we look at their predictions around the bond market, all 10 predicted yields to be lower than where they are today. The 10-year Treasury is just a little over 1.5%. They asked 10 strategists where they thought the stock market would wind up? All 10, significantly lower, predicted significantly lower than where the stock market is today. So you take the pandemic and you take all 20 of these predictions being wrong in Barron’s, it just shows how futile the prediction game really is. It’s because even if we knew perfectly how technology would unfold, if we knew perfectly how inflation would unfold, the pandemic has proven no one knows what’s going to happen. No one predicted with certainty an epidemic was going to happen. Certainly no one knew exactly how it would play out and what the recovery would look like. Or what the Fed and Congress and Presidents were going to do.

I think if you look at the risks that are out there, there are certain risks always in the background — war, terrorism. I still think the biggest risk that the market and the economy faces is a strong, coordinated cyber-attack. Particularly, on a major financial institution, like one of these multi-trillion dollar type institutions. To me, that’s the biggest background risk that’s always there. If you’re an investor and you see all of those things, you really need to take predictions with a grain of salt, whether you’re in the stock market or the bond market. You can also look at, well, where in the stock market? If you look at Vanguard, BlackRock, Goldman, and you say, “Well, where should the money be going forward?” Well, many of them are saying overseas, right? Europe, emerging markets, over the United States; smaller stocks over larger stocks. But they also said that last year and that’s not how it played out again.

So, my tip of the day, I’m going to give it to you early, Jonathan, is investors should always be investing based on their needs because the market is unpredictable. Instead of looking at investments and saying, “Which investments are going to do well this year, or next year should be stocks or bonds, U.S., or overseas?” You should be saying, “What do I need and when do I need it? What is the plan telling me? When do I need this capital? How do markets tend to play out over these periods of time?” And match up your allocation to your personal needs rather than to what anyone is predicting, what any strategist is saying, or how you think the world is going to play out over the next one-to-two years.

Jonathan: All right, Peter, so before I get to my tip of the month, I got one last question for you about risk in the year ahead. It is the enemy in the mirror, the risk that investors pose to themselves. We just had this remarkably calm year for the stock market. We also know that many people feel flush with cash, thanks in part to the actions of Congress and the Federal Reserve. For many people, there’s been a growing sense of complacency about risk in the stock market. For other people, they’ve been emboldened to take far greater risk. An increase in volatility in the year ahead, wouldn’t be at all surprising and that could unnerve investors. Do you think, Peter, that investors have lost sight of what their risk tolerance is?

Peter: Yeah. I think there’s one prediction that I think has a high probability of happening — it’s that what we have experienced, which is I think is 70 new stock market highs in one year, one of the lowest volatility years on record, meaning the market didn’t really go up and down that much. It just generally went up most of the time with very, very minor pullbacks for a full year. That is not normal. In a normal year, the stock market goes down 14%+. Somewhere during the year that did not happen. Volatility, meaning it goes up and down over 6%, 7% for many periods of time throughout a year is normal, that did not happen. So I think it’s a safe bet that the market has priced in everything happening, turning out to be really wonderful. I think one great trait of Americans… sometimes it’s great, is a very short memory, right?

So it allows us to cope with a lot of bad things and move on. But boy, when it comes to investing, is memory really, really, really short. I think that people learned the wrong lessons from the pandemic. I think even financial advisors — I look at all the high-fiving out there, and I think it’s overdone. I think listen, the pandemic, it could have been worse, right? We could have had instead of a less than 1% mortality rate, what if it had been 2% or 3% as indicated early on? What if there were not some way out of this, this potential herd immunity that we’re getting right now as this current variant spreads? Where would the markets be without the massive Fed intervention?

And so I think the people have learned that really bad things happen, then boom, in six weeks the stock market turns around, or a couple months it turns around, and then it doesn’t look back and it just goes up a little bit every month for forever. That’s not normal. So I think we’re going to have a few shakeouts. A normal correction from here you’re talking about 4,000, 5,000 points. I mean, people are going to freak out what it happens, and it could happen in the next couple months and it would be completely normal. I think it would be a very, very healthy reminder for people that how you’re allocated matters.

Jonathan: So Peter, based on your remarks, I come to my tip of the month. You mentioned in a typical year, you get a 14% drawdown. We just got through November and December. A lot of people were taking tax losses at the end of the year. That’s the time when people look at their portfolios and see if there are ways to trim their taxes. What I would say to listeners, is you should make managing your taxes a year-round endeavor. In particular, if we do get that 14% drawdown at some point in the months ahead, don’t wait until the end of the year to take those tax losses, to reduce your taxable income for 2022. Take them as they’re presented to you because by the end of the year, that tax loss, which could potentially knock $3,000 off your ordinary income and the tax due on that, that opportunity may be gone. So take tax losses throughout the year, don’t just do it at the end of the year.

Peter: Creative Planning clients know that better than anybody. In March, in the middle of the pandemic, we were tax harvesting and we were buying equities. We were not waiting for the end of the quarter, or the end of the year, which was too late at that point. So having that be active and throughout the year is the only key to capturing that opportunity.

Jonathan: Well, Peter, that’s it for another month. This is Jonathan Clements, Director of Financial Education with Creative Planning, speaking with Peter Mallouk, President of the firm, and we are Down the Middle.

Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.

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