Market report

FED tightens the screws, 2022 annual outlook

January 10, 2022
6 min
 FED tightens the screws, 2022 annual outlook

Chart of the week

Source: Yardeni Research: Central Banks Monthly Balance Sheets, Jan. 08, 2022.

The chart shows the size of the balance sheets of the central banks of the United States, Europe, Japan and China. In particular, the European Central Bank (ECB, blue) and the U.S. Federal Reserve (FED, red) have massively increased total assets during the pandemic period.

Why this matters:

To protect the economy from worse effects, central banks sharply reduced interest rates and expanded total assets. The majority of the balance sheet total was increased by buying up bonds on the market, but also with very cheap loans to commercial banks. This support for the economy is also called loose (or in this case, ultra-loose) central bank policy.

U.S. Federal Reserve Tightens the Screws.

The era of ultra-loose monetary policy is now over. In December, the U.S. Federal Reserve announced it would massively reduce the expansion of its balance sheet and stop buying bonds by the end of March. At the time, the central bank was not expected to stop this until June 2022. In the meantime, most market participants expect 2-3 interest rate hikes by the end of 2022:

Source: JPM Guide to Markets Q1 2022, page 23

Now this week, the next hammer blow came. The minutes of the December Federal Reserve meeting were published. From these, it is clear that not only bond purchases are to be stopped, but also the balance sheet total is to be reduced. This would then be a change in strategy from an (ultra) loose to a restrictive monetary policy within just a few months. Even the most pessimistic market participants did not expect this to happen until the end of 2022. The stock markets then also corrected downward accordingly.

A change from a loose to a restrictive monetary policy of the US Federal Reserve also requires an adjustment of the investment policy in most investment portfolios. It can be assumed that the European Central Bank will also make a similar move soon.

Annual Outlook

Normally, after this headline, readers expect clear predictions on how the stock market will behave in the coming year. Usually we do the same, but in the current pandemic period everything is different. In 2020 and 2021, central banks have intervened in financial markets as never before. The generous support packages from the states were added to this.

As a result, most countries have taken on so much debt as was otherwise only the case after a world war.

Source: Bond Vigilantes Blog, 10.11.2021

The chart shows the level of government debt relative to gross domestic product (GDP) of developed countries /blue) and developing countries (red). The debt is now higher than it was after the Second World War.

Various studies also show that about 1/3 of all Covid support money has gone into financial markets, which was one of the main reasons for the very good return of almost all markets in 2021.

Our forecast is that society will learn to live with COVID. Central banks will stop the ultra-loose monetary policy in 2022 and start to raise interest rates. Governments will reclaim the loans they made during the crisis. So far, we are seeing rarely high economic growth and it may be that the economy can survive these curbing measures unscathed. But this will only happen if the central banks and the states make the turnaround wisely and slowly.

And that is precisely why no prediction is possible at the moment. The central banks are proceeding in a relatively coordinated manner and are coordinating with the central banks of the other countries, even if they sometimes go their own way. It's a different story with the states. Political majorities can lead to decisions that are neither coordinated with other countries nor with the central banks. It is almost impossible to predict which country will react how wisely. The measures of the states have the potential to cause a crash on the financial markets.

In 2022, the fluctuations on the stock markets will therefore be higher than in 2021. One will have to change one's investment policy a few times a year and be prepared to adjust one's investment policy.

2020 and 2021 were the years for new business models in the digital sector. The shares of these companies were able to gain over 300% at times.


The chart shows an index created by Goldman Sachs that includes all technology stocks that have an innovative business model but have never made a profit. These include well-known companies such as Uber, Pinterest, Spotify and Slack.

We believe in the comeback of quality stocks. These are stocks with a proven business model that has been producing nice profits for years. The time for companies that only sell air and hope is likely to become difficult. Until now, capital to finance these losses was easy to come by and almost free. With interest rates now rising, that's getting harder and harder.

One of the most important issues, which will also be the basis for central bank policy, is inflation:

Source: JPM Guide to Markets Q1 2022, page 7

The chart shows how much inflation increased in 2021, but also that most market participants expect inflation to decrease massively again in 2022. We are more skeptical about this. The production chains are still completely out of kilter:

Source: JPM Guide to Markets Q1 2022, page 13

The chart shows an index from JPM that measures delivery times. The lower the index the longer they are. A small recovery is in sight, but it will take at least another year to get the production chains back on track.

An equally important point for inflation is unemployment, and when this is low, wages rise:

Source: JPM Guide to Markets Q1 2022, page 24.

The chart shows unemployment (purple) and job openings in millions in the US. The number of open jobs is higher than the number of unemployed people. In addition, some of the job seekers lack skills.

Due to the supply chain issues and the labor market situation in the U.S., we currently expect inflation to be higher than most market participants.

There are two ways to protect against high inflation. Investment in tangible assets and gold. The most prominent tangible assets for a liquid portfolio are equities. The bond ratio should be kept as low as possible in such a scenario.

In terms of equity investments, we prefer quality and substance stocks. Companies that are market leaders in an area/niche also have the possibility to increase prices if inflation persists.

Source: JPM Guide to Markets Q1 2022, page 24

The chart shows the sector weightings in the country indices (top) and in the value/growth indices (bottom).

In order to implement the strategy outlined above and focus less on technology and more on consumer and industrial stocks, the US equity market needs to be rather underweighted and the European equity market over weighted. In addition, we tend to find these stocks in the value rather than the growth space. Somewhat problematic in the value indices is the high proportion of banks. Here we will look for value strategies that tend to underweight this sector.

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