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Stock Market Opportunities in a Demand-Fueled Economy

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What You Need to Know

  • In the new year, GDP growth will likely slow but stay above trend in the 4% range.
  • Consumers continue to be bolstered by plentiful jobs and higher wages.
  • While broader inflation will resolve at some point in 2022, I expect both wages and shelter costs to stay elevated.

The market finally gained certainty last week when the Federal Reserve officially announced that it is shifting its policy approach. Through March, it will expand its monthly taper to $30 billion a month from $15 billion; based on guidance from committee members, we can expect three rate increases in 2022.

Despite the more hawkish tone, remember that for the next three months, it’s just a taper, which means the Fed will still be in the market buying until March. This will add more liquidity to an already flush system, so it won’t make much of a dent in near-term inflation levels.

Though omicron is spreading rapidly, we received promising news last week that the Pfizer and Moderna vaccines are effective against multiple variants; so far, vaccinated people are coping well with the virus. We will be watching economic indicators closely to see how the omicron spike impacts consumer demand and overall economic activity.

Despite inflation and COVID uncertainty, consumers continue to spend on goods and services. The Institute for Supply Management is reporting robust new orders, and demand for services is at record highs. These are strong indicators that we will see a much higher Q4 GDP number compared with Q3. In the new year, GDP growth will likely slow but stay above trend in the 4% range. 

With much uncertainty heading into 2022 around inflation, interest rates, persistent supply chain issues and COVID, I’m staying diversified in my equity portfolio, favoring cyclical, economically sensitive companies while maintaining holdings in select growth companies with large total addressable markets. 

Consumer Demand Remains Strong

Since consumer spending accounts for 69% of GDP, this is an important driver of economic growth. U.S. retail and food services sales rose 18.2% in November versus the same month last year, though November sales slowed markedly compared with October — likely due to the fact that many consumers did their holiday shopping early due to concerns about inflation and product shortages.

Consumers with pandemic fatigue are spending money on services as they hunger for experiences such as travel and eating in restaurants. This is likely to continue, as we still have pent-up demand, with $2 trillion in consumer savings and $4 trillion in money market accounts, according to Merion Capital. 

Consumers continue to be bolstered by plentiful jobs and higher wages. Total nonfarm payroll employment rose by 210,000 in November, and the unemployment rate fell by 0.4 percentage point to 4.2%. As of end-October, the U.S. had a whopping 11 million job openings, according to the latest Job Openings and Labor Turnover Survey (JOLTS).

With abundant jobs to choose from, national quit rates are still high, meaning workers feel confident they can leave their jobs and find new employment easily. At the same time, wages are increasing: U.S. nonfarm unit labor costs swelled by 9.6% in Q3. 

Inflation continues to surge for both consumers and businesses amid ongoing supply chain challenges. The U.S. consumer price index rose 6.8 percent for the 12 months ending November, the largest 12-month increase since the period ending June 1982. And the PPI rose 9.6% year-over-year in November, the largest advance since 12-month calculations began in 2010; it rose 0.8% month on month.

While broader inflation will resolve at some point in 2022, I expect both wages and shelter costs to stay elevated. The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index reported a 19.5% annual gain in September. Rents, which follow home prices, have also spiked, increasing 5% annualized, and the Atlanta Fed sees them reaching 6% by 2023, according to Merion Capital.

Given the strong demand and overall bounce back in the economy, expect to see significant GDP growth this quarter. The Atlanta Fed is forecasting 7.2% GDP growth for Q4; while that may be on the optimistic side, expect a large number.

Just look at the ISM Services PMI, which registered 69.1% in November, the highest reading since the inception of the index in 2008. ISM’s November New Orders Index registered 69.7%, maintaining October’s record. We likely will not sustain numbers like this into 2022, but I believe we will continue to see above-trend growth.

How I’m Allocating Heading Into 2022

Stock prices follow profits, so I’m encouraged by the record-high new orders number, a leading indicator for corporate earnings and capital expenditures. In addition, many companies are reporting higher levels of free cash flow, which will allow them to invest in infrastructure such as enterprise IT, as well as make shareholder-friendly moves such as buying back stocks and boosting dividends. These are positive signals for Q4 and Q1 earnings. 

For my equity portfolio, I maintain my focus on owning a barbell strategy of cyclicals and quality growth stocks. I favor cyclicals because we still believe that growth will remain above trend and inflation stubbornly high. Key sectors to consider are energy, materials, financials and consumer discretionary.

Though I am underweight technology, I maintain holdings in secular growth names with large total addressable markets, seeking exposure to areas such as semiconductors, artificial intelligence, electric vehicles, augmented reality, cloud computing and cybersecurity. 

The year 2021 has been one of rotation in the market. From January through mid-May, value outperformed growth amid the perception that COVID was under control. From mid-May through the summer, the Delta variant scare caused investors to rotate back to growth, and growth outperformed value. In Q4, it’s been somewhat mixed; value and cyclical stocks have generally outperformed growth, but select growth stocks have also done well.

The consumer is a central driver of the demand economy. All current signs point to a strong consumer with spending power: higher wages, numerous job openings, elevated quit rates and high savings rates. Add to that the Fed’s cautious policy and continued QE, which means more liquidity to stimulate demand.

As the Fed seeks to balance price stability with economic growth in the coming year, I recommend staying diversified with a barbell approach, keeping an eye out for quality companies with attractive valuations, focused management teams, robust margins, strong free cash flow and pricing power to navigate ongoing inflation pressures.

Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower Advisors LLC. She leads the firm’s Investment Solutions Group, which specializes in outsourced chief investment officer services, model portfolios, separately managed accounts, investment research and due diligence for Hightower Advisors LLC. Follow Stephanie on LinkedIn and Twitter @Stephanie_Link. Read her regular market insights here.


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