INVESTMENT STRATEGY GROUP OUTLOOK 2022

[Pages:12]INVESTMENT STRATEGY GROUP

OUTLOOK 2022

JANNEY MONTGOMERY SCOTT LLC Published: December 15, 2021

As we peer into the New Year, there are no fewer challenges to consider.

The pandemic is one we hoped would be a mere remnant of the past year. It lingers, but the world has become much more optimistic thanks to vaccinations and therapeutics leading to a shift to an endemic phase that could be effectively managed.

Additionally, on the global stage: Simmering Sino-American relations persist and a recent effort to re-engage with Iran may lead to a d?tente, which could curb the near-term risks associated with that country's efforts to nuclearize--a potentially destabilizing factor in the Middle East and oil markets.

Domestically, although shared globally, is a bout of inflation that has been running higher for longer than anticipated by central planners. This could invoke a shift in policy settings that complicate the macroeconomic landscape.

INVESTMENT STR ATEGY GROUP

OUTLOOK 2022

OVERVIEW

Certainly, there are always variables of concern for investors. The good news is the economy seems well fortified to overcome the aforementioned challenges, barring an extreme outcome. Growth is occurring at a rapid pace and while it will undoubtedly slow in 2022, its glide path is starting from an unusually high level. The Federal Reserve has begun to reduce its bond-buying regime to create flexibility if it needs to raise interest rates to address fears of rampant inflation. That is hardly a reason for caution, as policy will still be quite loose and likely remain well below the equilibrium rate for the next year or two. This view comes from our belief that inflation is likely to subside to a less-threatening pace while staying somewhat higher than the average has been for the past 20 years. Above-average growth without the constraint of tight monetary policy should underwrite a favorable environment for risk assets.

Economy & Equity Markets................................................................................................................................................ Page: 4 ?The economy could continue to expand at an above-trend pace. Labor markets are tightening and consumers are well

endowed, both of which underpin a robust pattern of consumption. ?Corporate-profit growth in line with nominal GDP should lead to a healthy increase in earnings again this year. Stock

prices should rise in a directionally commensurate fashion. ?Commodities, particularly oil and industrial metals, could build on gains from last year, as markets largely remain

undersupplied against a backdrop of rising demand. ?Geopolitical tensions, rising prices, and the uneven success of COVID-19 treatments could serve as pressure points that

may occasionally rattle, but should not thwart, the advance in risk assets.

Fixed Income & Interest Rates..........................................................................................................................................Page: 9 ?2022 will be a battle between inflation expectations and a supply/demand imbalance, the resolution of which will likely

see interest rates somewhat higher and the yield curve flatter. ?The Federal Reserve will wait until they have a clear read of post-bottleneck inflation to raise overnight interest rates,

meaning one--or at most two--rate hikes late in the year. ?Corporate-credit fundamentals remain very strong, and spreads should contract modestly, possibly letting both investment-

grade and high-yield credit outperform Treasuries. ?The tax-exempt municipal markets remain a source of relative stability, as issuance is muted and demand from high-net-

worth investors is growing amid high savings.

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 3 OF 12

ECONOMY & EQUITY MARKETS

The U.S. economy may see moderating growth in 2022, but on balance, the fundamental landscape remains quite attractive. We expect financial markets to be jostled from time to time because of the impending concerns already mentioned, but that should not derail prospects for risk assets to perform. Here are our expectations for the economy, equities, and fixed income in 2022.

MARK LUSCHINI, CMT Chief Investment Strategist

President and Chief Investment Officer, Janney Capital Management

Mark Luschini serves as Janney's Chief Investment Strategist and leads the Investment Strategy Group, which sets the firm's view on macroeconomics, as well as the equity and fixed income markets. In addition, Mark is the President and Chief Investment Officer of Janney Capital Management (JCM), the asset management subsidiary of Janney Montgomery Scott. Under his leadership, JCM has delivered competitive results across its suite of investment strategies and grown its assets under management to more than $3.5 billion.

Mark has spent more than thirty years in the investment industry. He draws on that experience to speak on topics related to macroeconomics and the financial markets at seminars, client events and conferences. He is frequently quoted in publications ranging from the Wall Street Journal and Barron's to the New York Times and USA Today. In addition, he regularly appears in various media outlets including CNBC, Fox Business News, and Bloomberg Television and Radio. He has an undergraduate degree in Psychology and an MBA in Finance from Gannon University and holds the Chartered Market Technician (CMT) designation from the Market Technicians Association.

ECONOMICS

After losing some momentum in the third quarter, driven by the outbreak of the Delta variant of COVID-19 and inventory logjams, the economy has re-accelerated as we move toward the end of the year. The recent discovery of the new Omicron variant of the virus is raising concerns about mobility restrictions and the economic impairment it could induce. There seems to be little public appetite for lockdowns outside of localized mitigation protocols, therefore, we do not look for a marked deceleration in activity as a consequence. We have highlighted in previous reports that a vaccine-evading mutation of the COVID-19 virus is a risk to our otherwise sanguine views about both current and forward-looking macro conditions. Obviously, time will tell to what extent Omicron, or another variant, introduces a risk to the healthcare system that is too great to bear such that policymakers have to impose tighter sanctions on public and general social behavior. For now, the economy is growing rapidly (Chart 1) and we expect that momentum to persist throughout 2022, albeit to a moderating but still above-trend pace.

Chart 1: US GDP

economy. The stock market is one of them since it has a notorious reputation for moving not on the news of today, but rather what investors extrapolate from it and project out what it is likely to mean for share prices nine to 12 months ahead. Chart 2 shows the ricochet rebound from the pandemic low continues to climb at almost a 45-degree angle, placing exceedingly high odds that the expansion currently underway has much farther to go.

Chart 2: US Leading Economic Index (LEI)

(Source: Janney ISG, Conference Board)

Consumers' propensity to spend is being monetized in malls, restaurants, homes and furnishings, and online purchases of goods. As a barometer of spending, retail sales, excluding automobiles, is giving a strong signal that the consumer is flush with cash (Chart 3).

Chart 3: US Retail Sales Ex Autos

(Source: Janney ISG, Bureau of Economic Analysis)

The Leading Economic Index (LEI) is a widely followed gauge because it includes economic variables that have movements that tend to precede changes in the overall

(Source: Janney ISG, US Census Bureau)

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 4 OF 12

Pent-up demand continues in the post-lockdown world, as consumers shift spending towards services and away from goods. Furthermore, consumers are set to propel economic activity for quite a while. This is important because personal consumption drives almost 70% of economic activity in the U.S. Consider the following charts as reasons to hold such an optimistic view.

The number of those unemployed has fallen dramatically and will likely soon approach 4%, a level rarely seen and only 0.5% from the pre-pandemic 50-year low of 3.5% (Chart 4). The tightening in the labor market should promote job security and wage increases--elixir for stout consumer spending. Job growth is the key to a self-sustaining economy, in other words, one that grows without heavy-handed monetary intervention. Chart 5 further endorses our view that this is what is developing. The JOLTS (Job Openings and Labor Turnover Survey) report illustrates the number of job openings that exist. Not only are there a near-record amount of unfilled job openings in this country, but they exceed the number of unemployed by approximately two million. Consequently, job creation is likely to continue at a heady pace for many months to come.

Chart 4: US Unemployment Rate

Moreover, consumers have money to spend, with overall excess savings standing at more than $2 trillion today. While that has contributed to gains in household net worth, both rising stock prices and home values have risen dramatically, further enriching American families. Today, household net worth is more than double the previous peak period before the Great Financial Crisis. Empirically, households tend to spend a portion of the gains in their wealth, so the rapid climb that can be seen in Chart 6 is further evidence spending should continue to clip along.

Chart 6: US Household Net Worth (Nominal USD)

(Source: Janney ISG, Federal Reserve)

A final point about the consumer: Years of debt destruction without a renewed appetite to re-lever personal balance sheets in a significant way means there is considerable scope for borrowing to take place. This is particularly the case when interest rates are so low and the service cost to cover existing family debt (Chart 7) remains near the lowest in more than a generation.

Chart 7: US Household Debt Service Ratio

(Source: Janney ISG, Bloomberg)

Chart 5: JOLTS

(Source: Janney ISG, Bureau of Labor Statistics)

(Source: Janney ISG, US Census Bureau)

Meanwhile, business activity is robust. The Institute for Supply Management (ISM) survey is a renowned source of information about current and expected order flows, employment, and capital spending plans. As shown in charts 8 and 9, the indices represent readings that are well above average for the past two decades.

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 5 OF 12

Chart 8: ISM Manufacturing Index

punches well above its weight because no other industry poses the multiplier housing construction does when you consider all the other tertiary industries impacted by it.

Chart 10: US Housing - Building Permits

(Source: Janney ISG, ISM)

Chart 9: ISM Non-Manufacturing Index

(Source: Janney ISG, US Census Bureau)

(Source: Janney ISG, ISM)

Finally, on the domestic front, housing is booming. It is said that housing is the economy. Approximately 60% of households own one. A house is a sizeable and durable purchase and it is very interest-rate sensitive. Because most homes are purchased with a mortgage, interest rates play a disproportionate role in affecting housing demand.

Chart 10 illustrates the strength in the housing market. Building permits are a leading indicator for housing because it signals activity associated with the construction and sale of a permitted home is likely to follow. While rising home prices could deter some would-be buyers for new or even existing homes, it has not slowed sales activity as of yet. Homebuilder sentiment is bullish based on traffic perusing new home inventories and the market for existing homes is deeply undersupplied.

Household formation is running at about 1.5 million per year and that figure could rise as the gigantic demographic cohort known as Millennials continue to age. That should produce a wave of demand, as long as jobs are steady and housing affordability remains reasonably grounded, that could last through this decade. While residential investment is a relatively small portion of GDP--at less than 5%--it

GLOBAL OUTLOOK Our primary focus on non-U.S. activity is China. A major concern is that China's growth is decelerating. Their National Bureau of Statistics reported growth in the third quarter was barely positive and its yearly gain of just 4.9% was the slowest in decades outside of the pandemic. Chinese leaders are grappling with fallout from the overlevered property developers that fed off the constant price appreciation in housing that was expected to continue in perpetuity. President Xi has taken a hard line on extending credit to the highly indebted development community, and has taken strides to cool the housing market from Chinese buyers using it as an investment vehicle. Under his Common Prosperity initiative, he is taking steps to make housing more affordable, including applying a property tax for the first time.

Chart 11: Chinese GDP

(Source: Janney ISG, National Bureau of Statistics of China)

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 6 OF 12

Certainly, China has introduced a few measured moves to stem the decline in growth. At best, it seems those moves may have stalled further erosion, but it has not been forceful enough to reflate activity in a meaningful way. The consequences to other countries whose exports feed China's needs for food, oil, metals, machinery, and equipment, is that trade with China represents a large portion of their GDP. It is 15-25% in many cases, so a drop-off like the one we have seen has severe blowback, especially through the emerging-market complex.

We expect China to make a more serious effort to reaccelerate the economy in the first half of 2022. As hosts of the Winter Olympics in February, followed by President Xi's inauguration as "president for life" during the fall National Party Congress, authorities have every reason to present the achievements of the Communist regime to the world in the best light possible. That will serve to boost imports, which then should aid the growth of those export-reliant nations.

Bottom line: We believe the macroeconomic climate is expansive, but perhaps not synchronized. We expect inflation to cool somewhat, allowing central banks to slowly pivot to withdrawing accommodation. Overall, we believe the residual impulse from years of uber-loose monetary conditions and an unprecedented level of fiscal stimulus unleashed over the past 18 months could keep economic momentum sufficiently strong to overcome any lightly imposed distortions the coronavirus, or geopolitical dustups, generate.

? Commodities ? Increasing global demand and attentive supply management principally administered by OPEC members Saudi Arabia and Russia should help boost oil prices. Industrial metals stand to benefit from increased manufacturing activity, de-carbonization, expanding purchases of electric vehicles, and fiscal policies both here and abroad designed to address aged infrastructure and spur jobs and economic growth. As a hedge, gold might offer support against a flaring geopolitical risk and path-risk for inflation.

Our prognostication for the U.S. stock market's path forward includes three potential outcomes that emanate from various economic scenarios that could unfold. We assign a likelihood to each to express our confidence level in the forecast presented. In preview, we continue to skew bullish, which is indicative of our belief in the sustainability of the global equity rally that's been underway for more than a year. While going forward it seems unrealistic that the returns earned in 2021 will be repeated in 2022, we do, however, envision possible further upside that should prove flattering to balanced portfolios.

INVESTMENT IMPLICATIONS

The following outline demonstrates how we would express our central thesis that economic growth will continue, albeit moderating somewhat from 2021's sizzling pace. This, in turn, should enable the advance in stock prices, and risk assets in general, to continue.

? G lobal Equity Markets ? U.S. equities should perform well, although valuations and margin pressures could weigh on prices should profit growth expectations fail to develop along the current projections. European equities are poised to benefit from a valuation re-rating as the continent's vaccination campaign allows for the removal of COVID-19 mitigation protocols. Emerging markets may become attractive at some point next year since we expect China to begin taking meaningful steps to reflate its economy in the year's first half.

? Sectors ? We favor overweighting pro-growth sectors, including Industrials, Materials, Energy, and Financials. The Consumer Discretionary sector also stands to benefit from the potential release of over-endowed savings, particularly throughout the service industries. Technology and Health Care may become increasingly attractive as the year unfolds if the growth deceleration we expect occurs in a more pronounced fashion heading into 2023. Tactically, we are favorably disposed toward small-company stocks as beneficiaries of robust domestic conditions.

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 7 OF 12

VARIOUS ECONOMIC SCENARIOS AND PROBABLE OUTCOMES

Scenario 1: Nirvana

The economy grows at roughly 4%, but nominal GDP advances at 7% or above. Since corporate revenues tend to pace near the inflation-adjusted growth rate of the economy, that spurs profits to rise some 8-9% yearover-year.

Inflation, while remaining elevated, begins to subside, relieving the Federal Reserve from having to embark on a rate-hike campaign until late in the year at the earliest. Governmental policy remains a tailwind as outlays for infrastructure and other items prevent a fiscal cliff from occurring.

Negotiations with Iran lead to a d?tente, cooling fears that Iran's rapid approach to nuclear breakout capacity will lead to a heated confrontation. China, hosting the 2022 Winter Olympics and later in the year celebrating the 20th National Party Congress where President Xi is expected to be elected to a third term, tempers any desire to provoke trade disruptions or a military confrontation.

Foreign equities post particularly strong gains while domestically, pro-growth sectors, such as Energy, Industrials, Materials, and Financials lead. Commodities also produce strong returns, led by oil and industrial metals. The S&P 500, despite more volatility than last year, benefits from multiple expansion and climbs to 5,200.

Probability: 35%

Scenario 2: Navigating the Crosscurrents

The economy loses momentum throughout the year, but growth remains positive. Labor markets remain healthy, but wage gains soften as the heightened incentive to lure employees to fill job openings fades. Still, excess savings and improved sentiment stokes consumers' propensity to spend which, in turn, drives economic activity. Inflation remains sticky at a higher level than monetary officials deem comfortable, and the Federal Reserve embarks on a slow but earlier-than-expected effort to withdraw its accommodation.

COVID-19 moves to an endemic phase and restrictive lockdowns are avoided. Geopolitical tensions with Iran and China simmer but do not lead to a major volatilityinducing clash.

Fiscal spending only amounts to a marginal tailwind as, like a time-release capsule, outlays occur only incrementally over many years. Profits grow, but margins are squeezed by higher input costs for materials and labor. Multiples contract, but not so much as to counteract the rise in earnings, leading stock prices to rise. Commodities, particularly oil and industrial metals, perform well as years of underinvestment and the move toward global de-carbonization creates demand. The S&P 500 reaches 4,900.

Probability: 60% (our Base Case)

Scenario 3: The Curtain Falls

The rapid pace of inflation that emerged last year fails to abate. Federal Reserve officials, realizing they have fallen well behind the curve, begin raising rates at a pace that is quicker than expected, catching market participants offside. This occurs in concert with many other central banks around the world, some of whom have already raised rates, which serves to slow domestic and global activity alike.

The combination of higher-than-average inflation and decelerating growth promotes talk of stagflation if not the increasing risk of a recession in 2023. With the loss of any new fiscal impulse and higher taxes on corporations, profits fail to materialize to the level that analysts had anticipated. Stocks are de-rated as the price-to-earnings ratio for the market compresses and the equity risk premium rises.

Defensive growth sectors are the stalwarts led by Technology and Health Care. These sectors are eventually joined in leadership by economically insensitive areas like Consumer Staples and Utilities as the yield curve comes close to inverting, which often foreshadows an economic contraction. The S&P 500 Index gyrates throughout the year, but ends about where it began--resting near 4,600.

Probability: 5%

BOTTOM LINE: ENSEMBLE FORECAST

Considering the probabilities around three different but plausible scenarios, we look for the S&P 500 Index to reach 5,000. Indeed, not unlike last year, we believe the risks are asymmetrical with there being greater odds that target is ultimately proven too low rather than too high.

? JANNEY MONTGOMERY SCOTT LLC ? MEMBER: NYSE, FINRA, SIPC ? JANNEY OUTLOOK 2022 ? REF: 503552-1221 ? PAGE 8 OF 12

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