This week, Director – Financial Planning Gabe Adams, CFP®️, MSPFP, reviews stock and bond performance, covers the latest inflation news, and provides several updates from the most recent meeting of the Fed.

Transcript

Hi there, I’m Gabe Adams, the Director of Financial Planning at Reilly Financial Advisors. Well, here we are with only two weeks left in 2021. And what an interesting year it has been. To name just a few notable headlines from this past year – the meme stock craze, political turmoil in the US and abroad, China’s regulatory crackdown and trouble in the Chinese real estate market, billionaires in space. And of course, the continuing pandemic, supply chain issues, and inflation. We’ll touch on those latter themes more in a moment, but first, let’s look at where we stand. After all that, it’s been a generally positive year for stock market returns.

US stocks look poised to finish the year out with strong results, which reflects what has been a strengthening economy in the face of a lingering pandemic. Developed international markets have had relatively weaker but still positive results. However, emerging markets have fallen behind, not due in small part to the aforementioned issues in China. To change gears, the broad US investment grade bond market may end the year in the red. With historically low yields, and potentially rising interest rates, bonds have generally struggled. Additionally, inflation would negatively impact bonds, as it erodes the purchasing power of the fixed bond coupon over time.

On that front and as we’ve highlighted before, inflation has been running hot. The latest readings showed a nearly 7% annual increase in the consumer price index, or CPI, which was the largest year over year increase in almost 40 years. Additionally, core CPI, which excludes more volatile goods like food and energy, showed a smaller, but still somewhat large, increase as well indicating that inflation has become more broad-based.

As we’ve stressed, after years of low inflation, we’ve seen an increase in large part due to pandemic and supply chain related issues. However, the Fed did recently communicate a meaningful change in strategy. First off, the description of inflation as “transitory” has been retired. Although one could argue what that really means considering the definition of transitory is “not permanent,” this does signal that inflation persisted longer and stronger than what the Fed originally anticipated. Also, the Fed will accelerate their tapering of bond market purchases that were used to inject liquidity in support of the economic recovery. This could lead to an end of asset purchases by March of 2022. Finally, Fed Chair Powell indicated a change in rate hike projections. We could now see three rate hikes in 2022, followed by another 3 hikes in 2023. If the Fed stays on this course, the fed funds rate would be in the 1.75% range by the end of 2023.

So, what does this all mean? Given the many headlines of 2021, including a continuing pandemic, underlying economic growth has strengthened and we are poised for generally strong stock market returns to close out the year. The bond market is a different story, and inflation continues to be a notable headline. The Fed has pivoted their stance, and we’ll see how their tightening plans play out in 2022. Underneath the surface, growth could cool from the current pace, especially given the lingering uncertainty surrounding the Omicron variant. It is too early to say, but it’s possible the Fed may need to adjust their position again if the data changes. Among all of this, an interesting detail is that the the 10-year breakeven rate, or the difference between the yield on 10-year treasuries and 10-year TIPs, still hovers in the 2.3 – 2.4% range. As such, this means that inflation expectations over the next 10 years remain modest, although somewhat elevated from the last 10 years.

As always, our investment committee will continue to monitor developments on your behalf and make any adjustments seen in your best interest. Additionally, we remain focused on the long-term and what matters to you. In that sense, your Advisor will continue to work with you to determine an investment allocation that is appropriate and that considers your specific financial situation and your goals. With that, have a great weekend and happy holidays!

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