January 5, 2021

2021 was a year of two halves.  The first half characterized by extremely rapid growth, rebounding from year-ago stagnation; followed by significant slowing into year end.  Financial markets ran parallel to this, seeing interest rates and growth stocks climb dramatically in the first few months, followed by a levelling off and slight decline while small and emerging market stocks went sideways and down. While at the same time, the largest companies which dominate passive investment strategies (led by technology of course) grew throughout the year.

There may be a reason, or simply coincidence that the first half of 2021 saw a dramatic decline in daily US Covid-19 cases through the end of June, then a dramatic increase in August/September and then further upswing (after a mild decline into Halloween) the last two months of the year and is increasing right now. As cases have come up, people get sick and miss work, some employers close their doors or go to reduced hours, some people stay in and other reactions will cause growth in the US to grow, less smoothly shall we say. The Omicron variant spreads far more rapidly. However, many more people are vaccinated, or have already contracted Covid and there are better treatments. We could expect the impact of more infections to be less than in previous surges. However, if the sheer number of people infected is greater and more concentrated in a shorter period of time, we could see similar hospitalizations and deaths as we did in the summer. I see a silver lining in that the rapid spread, alongside a large number of vaccinated people, a scenario where we get to an 80%+ herd immunity for a long enough period and Covid will die out.  So far, hospitalizations vs. new cases is smaller than in the summer during the Delta surge.

The dichotomy of the two halves of 2021 can be seen in stock markets too. The small-cap index etf, IWM, climbed 16% in the first 42 days of 2021, then took the remainder of the year to gain two additional percent. Emerging market stocks climbed initially, gaining 12% then falling 15% to end the year down 3.62%.  Most of that decline occurred after June 30th. While the S&P500 had a banner year (+28%), counterintuitively, more aggressive investors who often have greater exposure to small stocks and emerging markets likely saw their portfolios underperform the Dow and more moderate-risk investors. Other developed markets saw gains of 11%- 17%, as the SP500 was buoyed by the energy and tech sectors (up 53% and 28% respectively). Fortunately, we were overweight these sectors all year, which helped mitigate the lagging bond and metals markets.

The dramatic economic growth numbers posted in the first half are due in large part to ‘base effects. This means we started from such a low number, a shrinking GDP in early 2020, that in 2021 when everything came back online, the growth recorded was significant, at over 6% in each of the first two quarters.  These (and the 3rd quarter in 2020 at 31%) were the highest rates since 2003. Given the inflation we have seen result from supply chain constraints while at the same time stimulus checks were sent out, the question remains, how much of this growth is ‘real’?   Employment gains and wage growth will keep upward pressure on inflation, but given our population growth is stagnant, once supply chains get into equilibrium, and lack of further stimulus checks, inflation is likely to recede, perhaps dramatically. If the work is worth more than the price growth, real growth should stabilize around 3%.


US GDP at the end of September 2019 was $21.51 trillion.  This level was exceeded in the first quarter 2021 and in September grew to $23.2trillion, an increase of 7.86% over two years. A growth rate of almost 4% per year is considered fast in a developed economy. A key component in this calculation is inflation. When measuring ‘real’ growth, we must factor in inflation. Otherwise, higher prices on the same amount of goods and services would look like growth.  

In ‘real’ terms we are only just now exceeding the pre-Covid GDP level. This summer, when growth was flat month to month while prices went up, we experienced just a touch of stagflation.

If wages and employment continue to grow faster than inflation, ‘real’ growth can continue. Growth in wages has subsided, while the number of employed has increased alongside inflation. This has had a flattening effect on real income and a moderation in real consumption. These are the leading numbers that show us real growth will not continue at 4% but will recede to a slower growth rate.

If real wages and consumption slow, only credit expansion (borrowing) will allow us to grow at a faster rate. And if the Fed is reducing liquidity/raising rates, this may not occur.


Stocks, especially US stocks did very well in 2021, led by energy and technology shares. We know that share prices grow and contract more than the general economy, as markets are a bit more emotional. With government stimulus, near 0% interest rates (for banks), and a turning tide in the battle against Covid a robust year for stocks was not difficult to predict. The extent of the gains, however, is surprising.

Other financial markets did not fare as well. Ex-US stocks were far more muted, while emerging market stocks, precious metals and bonds fared poorly. Europe led, while Asia was negative for 2021.

I expect markets outside the US to catch up a bit with the US. And while Asia and Emerging markets have fared the worst, those are areas that could outperform.

While low rates and a rebounding economy are conducive to a growing stock market, an argument can be made that markets are a bit ahead of themselves.  Long time readers have read my thoughts on valuations in the past. Price is what you pay, value is what you get. A few common metrics are price/$1 of earnings, price/$1 sales or price/$1 worth of assets. We have spent most of the time since 2008 in extremely high valuation levels with no negative consequences. Market historians who study long term valuations often argue that there must be a ‘reversion to the mean.’ That is, at times of stress or recession, stock values should come down to or below long-term averages.  This was only the case briefly in 2008, and in the era of 0% interest rates have only seen extreme values get more extreme.

The point I want to make, is that the past 13 years, in a 0% world, valuations and prices are anything but normal. A mean reversion to long term averages would see greater than 50% market decline.

Realizing that the stock market is more emotion than earnings, prices can continue to climb especially as we all feel good about employment and a decline in Covid cases, I expect a good market to start off 2022. We could see some headwinds as Omicron burns its way through the populace but after the surge declines in several weeks, it will feel good.  Inflation should decline as well as supply chains continue to come back into line. The real wild card is how much the Fed and markets move up interest rates.  A major linchpin in the past 10years of this bullet proof market has been 0% rates.  If rates climb too fast while growth in wages plateaus, it will feel bad and 2023 or 2024 could see some level of “adjustment”.   Market returns for 2022 will likely be more muted with net gains of maybe 5% with variation over the year more like 15%.  

Inflation, Interest Rates and Gold

The combination of broken supply chains and lockdowns around the world, while stimulus checks were sent out has had a major impact on inflation. In my opinion, those stimulus checks were necessary as the entire economy was shut and the people most effected were in tourism and hospitality, which are generally lower wage jobs. 70% of Americans cannot put together $500 in an emergency. Those most effected by the shutdowns fall into this category. The stimulus checks prevented massive mortgage, rent, credit and auto loan defaults which would have had a greater impact on markets. Sending checks to every single person though, was overkill.

While some states ended supplemental unemployment payments in an effort to fill job openings, it appears there was little impact.  Unemployment rates were on the decline already, and the change in policy does not appear noticeable. Oddly, Ohio’s unemployment increased (blue line).

Over the past 10 years immigration has been in decline. During the pandemic immigration came to a halt as borders were closed and travel restrictions in place. Immigrants usually work the lowest skill jobs that Americans will not do. Food production/harvesting, construction/manual labor jobs are more than 25% filled by immigrant labor, legal and illegal. Immigration came to a halt in 2021. In order to fill these jobs today, employers are increasing wages and passing along the costs, as another source of inflation. The chart below shows negative immigration growth, which means a standstill in net growth. In 2021 immigration started up again, but at a slower pace than in the past.

The US needs immigrants for the low wage, low skilled jobs Americans will not do, for the pay rate offered. A moderate amount of immigration keeps inflation low.

As supply chains free up, stimulus checks dry up, and immigration numbers move up, we should see inflation pressures decrease. However, we ARE in a new era of rising interest rates for the next several years at least. It just will not be straight up. I expect to see rates decline and remain essentially stable through 2022.

As inflation pressures subside, market rates will decline, and bond prices should get a decent boost prior to another period of increases.

Gold, which many people will tell you is a hedge against inflation has not been doing that lately. Funny thing about gold is that it is ‘something’ to everyone at a given time. Long term, its an inflation hedge; short term is a ‘flight to safety,’ and in the medium term it’s a risk diversifier.  Gold actually performs best in times of overall growth.  Similar to bonds, I expect gold to do well in the first part of the year but beyond that we could see a very large potential price range.


The rebounding economy, healthy job growth, and rising wages will buoy the economy further in 2022. Inflation could derail workers’ real incomes though. Normalized immigration and loosening of supply chains are already underway and should show in the data for January/February (released Feb/March). While Fed policy is set to raise key interest rates in 2022, by an estimated .75%-1.25%, from current target of 0-.25%, lowered inflation pressures may reduce this. Higher interest rates could be a major headwind to stocks however, as the justification for sky-high valuations is reduced. As the Omicron surge passes emotions will turn more ‘risk-on’ and could be a source of demand for stocks. Areas outside the US namely, Asia and emerging markets could be source of outperformance in 2022 and further out. While I am optimistic about the first part of 2022, excessive valuations, extreme leverage in financial markets and an uncertain Covid impact are areas that could be sources of volatility as we enter a new era of rising interest rates.

Adam Waszkowski, CFA

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