We recognize on this Martin Luther King Jr. Day, that the need and opportunity for a more just and equitable society creates both personal as well as professional motivation for us. For those of us investing our money towards that outcome, here are some of the main headwinds and developments to watch for in 2022.
Inflation has been our primary concern recently. The odds of rate liftoff at the FOMC’s March 16th meeting have surged and the bond market has priced in a 90% probability of a 25 basis point (0.25%) rate hike. The 10-yr Treasury has popped up from 1.63 to 1.83 since the start of the year, quickly reaching its highest point two years.
During inflationary periods, the stock market will generally underperform and bond prices will decline as well, especially for long duration bonds. If you haven’t already, it’s a good time to review your long-term bond holdings and determine what federal lending rate would warrant replacing each of your positions with a higher-yielding issue. Generally, we’ve been overweighting in shorter durations in recent years, with the expectation that rates would rise at some point, so thankfully we’ve mitigated this issue substantially for our clients.
Your stock portfolio should be reviewed and adjusted as well. If you haven’t yet rotated away from cyclical and expensive tech-heavy stocks toward more defensive positions, then you may be regretting that now. The NASDAQ composite index has already dropped -10% YTD, compared with the broader market loss of only -5%. Certain industries and sectors will continue to get pummeled during rising interest rate environments.
In addition to inflation headwinds, subsidies are also expected to diminish this year.In the first quarter of 2020, government subsidies amounted to 0.4% of GDP, 5.8% in each of the next two quarters, and 2.4% last quarter. That share will continue to decline. Retailers and manufactures will continue to feel inflationary impacts on their bottom lines. Earnings expectations are tempered by inflationary supply pressures for inputs to production, particularly related to energy, meat, semiconductors, etc., in consumer staples and discretionary products. Our exposure to these sectors has been reduced this year. Pressure to increase prices will likely prevail over diminishing margins with demand remaining historically high.
Another current challenge is the reduced likelihood of passing the Build Back Better jobs plan with any meaningful provisions at this point. The more regressive the plan becomes in negotiations, the less it will benefit struggling families, however, the more it is geared toward corporations, the more likely it will increase their profits and prospects, growing stock prices and exasperating economic disparity. If any additional relief stimulus is passed, we expect that our long-term portfolio holdings in alternative energy and sustainable infrastructure will be boosted this year.
DEVELOPMENTS TO WATCH
The Securities and Exchange Commission and Department of Labor have been working to produce some regulatory standards for ESG investing, which is a sign that our industry is maturing, and we take that to be a good thing for humanity. Whether the regulations will require any substantive floor from which a sustainable financial system might flourish remains to be seen. However, we are excited to see what the first iteration will look like and to engage in the process of helping to refine and improve it over the years to come.
One area the SEC is unlikely to weigh in on, pertains to shareholder activism. In addition to screening portfolios based on ESG factors, some of us view active engagement as a more powerful way to effect positive change while adding value for all stakeholders. Last year we witnessed some unprecedented victories, such as Engine No. 1’s ousting of Exxon board members due to their failure to consider the risks of climate change in their business planning. Activist shareholders generally were more successful in 2021 than historically and we expect this trend will continue as the mechanisms and coalitions for change continue to grow and tighten. We are watching close this year to see what the next boardroom battle might be!
Meanwhile, as we search for investment opportunities, rising rates would typically benefit banks who will receive greater income from loans. Excess deposits from increased household savings have not been able to be lent out due to lack of demand and low returns on lent funds. Industrials, materials, and energy are also sectors expected to outperform during this cycle. Perhaps more interestingly, we are also watching thematic opportunities such as in the meatless food business. Bloomberg reported last year that plant-based food products will surge 451% over the next decade, and already the term “meatless” is Googled three times more than gluten-free and vegetarian products.
Another trend to watch as the Feds increase rates is M&A activity (mergers and acquisitions), which hit new highs in 2021 and are expected to continue in 2022. Anecdotally from our industry, as the ESG and impact investing space grows and matures, we have seen many groups fall apart and some others merge or get acquired while the smaller individual firms struggle more and more to remain competitive in the field. Amidst the shuffling, numerous senior, pioneering advisors who have been focused on socially responsible investments for many years, have approached us about transitioning their books of business to our firm and moving toward their own retirement. While money is still cheap and valuations are high, we are prepared to consider more opportunities for mergers and acquisitions in the year ahead.
Regardless of which way the markets go this year, we want to thank you for your trust in our firm and commitment to invest in a responsible manner. We hope we can see you and each other in person this year!
 2021 was a blowout year for M&A – 2022 could be even bigger (kpmg.us)