Stock prices accelerated their gains during the fourth quarter, generating a highly profitable year for investors. Consumers celebrated the reopening of the economy with record levels of spending, allowing companies to report record profits. Capital was available at rock-bottom interest rates, and companies did their best to ramp up hiring. The surge in economic activity revealed some bottlenecks and worker shortages, causing a worrisome bout of inflation that now has the full attention of the Federal Reserve. It is taking longer than expected to put the pandemic behind us, and another alarming round of COVID cases presents health and economic uncertainty as we prepare for this year’s mid-term elections that could change the balance of power in Congress.
Rising profits and easy access to capital propelled market values to all-time highs. People were eager to return to restaurants, travel and other social activities as constraints eased. Businesses struggled to hire employees fast enough to keep up with the surge in demand. Our nation’s unemployment rate improved to a mere 3.9 percent by the end of the year, just shy of the 50-year low of 3.5 percent reached prior to the onset of the pandemic. There are more open job opportunities than there are job-seekers available to fill them, and competition for workers is prompting the largest wage increases employees have seen in many years.
A worker shortage combined with supply-chain bottlenecks made it difficult for businesses to keep up with the buoyant demand for goods and services. Rebounding demand and constrained supply is a prescription for rising prices. The annual inflation rate accelerated to 6.8 percent, which is the highest level in more than 40 years. Food, energy and vehicle prices experienced some of the most pronounced increases. According to Edmunds.com, the average price for a used car jumped 39 percent in the past year to $29,011, while the average price for a new vehicle rose to $46,000. Home prices also surged, leading to a record of $1.61 trillion of new purchase mortgage lending during the year, due to high demand for housing, record low interest rates and low inventory of homes for sale.
Persistent price increases during the year prompted the Federal Reserve to change the tone of their regular commentary. Initially considered “transitory,” the rising inflation figures now merit a change in monetary policy. The Fed is curtailing its open market bond purchases and will begin raising short-term interest rates. The Fed has indicated its intent to raise short-term interest rates three times this year, with the first rate increase probably occurring with the March meeting of the Federal Open Market Committee. The Fed must walk a fine line. It is their job to keep inflation from becoming a problem, yet they do not want to entirely stall economic growth. So far, the bond market has reacted with relative calm. The yield on 10-Year Treasury securities saw mild upward pressure, wrapping up the year at a modest 1.52 percent, although the rise in rates has accelerated into the new year. Home buyers can still find attractive mortgages with interest rates around three percent. We expect capital markets to be sensitive to the Fed’s actions and commentary in coming months.
The pandemic increased the role of government in our economy. Remote work, online school, vaccination requirements, social-distancing regulations and other measures put in place by federal, state and local officials to combat the pandemic have changed the economics of many businesses. People have been remarkably resilient in the face of daunting uncertainty and changes to their daily activities. As with many other viruses, COVID may end up being something that we are unable to eradicate, but rather something we learn to live with as our healthcare system gets better at diagnosing and treating it. In the meantime, approaches to dealing with the virus have further divided an already polarized electorate, and they are expected to be contentious topics during the upcoming mid-term elections.
Roughly one-third of the 100 Senate seats and all 435 of the House of Representative seats are up for election every two years. This year’s mid-term election will determine whether the Democrat party retains their narrow majority control of both houses. The Senate is currently evenly divided, with Vice President Kamala Harris providing the swing vote that gives Democrats a slight majority. In the House, there are 222 Democrat representatives in a chamber that requires 218 for a majority, and there are three times as many incumbent Democrats (17) choosing to retire from office than Republicans (5) this election. Given the importance of this year’s election in determining control over a narrowly divided Congress, it seems likely much of the news cycle will be devoted to political topics as the year progresses.
Investors had a rewarding 2021, and the new year gets underway with a growing economy, strong corporate profits and rising wages. Capital markets will have to contend with some headwinds in the form of tighter monetary policy by the Fed, high levels of inflation and multiple geopolitical risks. There will likely be an upward bias on interest rates, and rising wages will squeeze companies’ operating margins. These pressures may cause volatility in the capital markets. We continue to count on stocks to provide growth in the value of investor portfolios, while a conservative posture with bond holdings can help soften any rough patches that might arise in stock prices during the coming months.
Please contact us if you have any questions. We send our best wishes to you and your family for a great new year.
