Strategic Income Outlook: One Heck of a Year

As we reflect on 2021, we can’t help but think that it was one heck of a year. While we had much to worry about, we also had much to be thankful for. Most importantly, despite two major Covid variants, Delta and Omicron (that latter of which is still very much with us), we’ve mostly managed to return to our pre-pandemic lives. In addition, the economy bounced back in 2021, delivering strong corporate earnings despite the continued snarl in global supply chains and rising inflation. On the other hand, companies still cannot hire enough workers to meet demand, though we are seeing some improvement there. And, of course, the Fed finally acknowledged that this inflationary bout may not be transitory after all.

Given that one can only invest looking forward, it is important that we understand the magnitude of the potential headwinds we face versus the tailwinds and their possible impact on the markets we invest in. Our headwinds remain continued inflation, rising interest rates, further lockdowns, and a less accommodating Fed. Our tailwinds are healthy corporate profit growth, strong consumer demand, and continued improvements in the labor market. Given these crosscurrents, we think it is critical to find the right balance between offense and defense. Sometimes it is better to play defense by finding calmer ports to wait out the storm than it is to make a prediction and bet on the outcome.

Corporate profits were very strong in 2021. The FactSet consensus estimate for 2021 S&P 500 earnings growth is 45.1%, which is extraordinary given the myriad challenges the economy faced. The 2022 consensus earnings growth estimate is considerably lower, currently standing at 9.2% − still a very healthy number but a marked slowdown from last year. (Note that this estimate is likely to be revised many times throughout the year.) The real question is whether equities can continue their winning ways. The S&P 500 returned 29% in 2021, following an 18% rise in 2020, and a 31% increase in 2019. While we like many of the current economic underpinnings of the market, we feel stock selection will likely be critical to success in the new year, as investors will be confronted with the potential for rising interest rates combined with the headwinds of slower, albeit positive, growth, the possibility of P/E contraction, and the prospect of continued supply chain disruptions due to the pandemic.