| wealth management  by Brad M. Weafer, CFA | Chief Investment Officer

There is an old saying that suggests “hope” is not an investment strategy. After the last two years under the specter of Covid-19, we could all use a little bit of hope this holiday season. Just as my children are hoping for Santa’s presents under the tree, we at Boston Financial Management have our own wish list for things we hope to see in the New Year.

WISH LIST FOR 2022

1. Endemic to Replace Pandemic

It is sometimes difficult to remember what life was like before the pandemic interrupted everyone’s personal and professional lives in early 2020. Almost two years later, with only part of life resuming, things are still not normal. This summer, the Delta variant slowed progress on lifting restrictions and a wide-scale return to the office for many workers. Just recently the Omicron variant is causing concerns as infection rates have spiked. While it is discouraging to continue to hear about new waves, travel restrictions, and a growing fear of infection, the data coming out of South Africa is encouraging that the latest variant is less severe with fewer hospitalizations (see Figure 1 below) and lower mortality rates. These episodes suggest we may have to continue to live with the virus, but if the world can transition from a pandemic to an endemic, we can adopt a structural shift in how we manage the virus as the global economy grows.

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2. Inflation Proves Transitory

In November, the annual U.S. inflation rates increased to 6.8%, a 39-year high. When we last wrote about inflation in May, we explained how post-pandemic spending, combined with major monetary and fiscal policies, were creating both outsized demand and limited supply. We expected those distortions would ultimately correct and the period of abnormally high price increases would prove temporary. We continue to hold this view, though it is clear supply chain challenges have been far more pronounced than we expected, with natural disasters exacerbating an already difficult environment. We are hoping a year with less stimulus and improved supply chains will allow for moderating inflation sooner rather than later. Over long periods, inflation correlates well with demographic growth (see Figure 2 below). Fertility rates have been declining for a decade to a new low over the last year, leading us to believe that the threat of inflation is less concerning secularly.

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3. Continued Outperformance from U.S. Equities

Demographics are not the only driver of inflation. An economy is made up of people that produce goods and services. Countries with a growing population of working-age people can more easily expect their economies to grow. It is prudent to diversify geographic exposure, but deciding on the right mix of domestic and international exposure within a portfolio is an equally important choice. This choice has had dramatic implications on investors’ performance over recent years. The Organisation for Economic Co-operation and Development and the World Bank (see Figure 3 below) forecast the U.S. working-age population to grow at less than one percent a year through 2050. This is lower than the ~1% per year we have experienced the last 30 years but decidedly better than almost all of the developed world and China, where the working-age population is expected to decline. On top of faster-expected growth, we favor the U.S. for its better aggregate corporate profitability, higher productivity, and solid overall corporate governance and shareholder orientation. This view has proven accurate over recent years. The S&P 500 has outperformed the MSCI All Country World Index excluding the U.S. by over 8% per year over the last five years. We expect this to continue going forward and have positioned portfolios accordingly.

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4. Sustainable Margins

Earnings per share are the lifeblood of equity prices. The direction of corporate profits directly impacts an individual company’s stock performance. While certain companies can grow without the help of the cycle, economic growth is needed to drive the stock market in aggregate. Current consensus forecasts call for between three and four percent GDP growth in 2022. Likewise, current analyst consensus estimates imply 7% sales growth for S&P 500 companies. That is a solid backdrop for profits, but faster earnings growth requires an improvement in margins from what is already record levels recorded the last two quarters (see Figure 4 below). Just holding the line on profitability would present investors with a healthy backdrop for returns in 2022. Sustained levels of profits would be a welcome gift this holiday season.

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5. Better Breadth

2021 has been a difficult year for stock pickers. According to Goldman Sachs, just 32% of large-cap mutual funds beat their respective style benchmarks through the end of November (see Figure 5 below). Hedge funds have fared no better, with the typical fund delivering flat year-to-date returns, compared to +23% for the S&P 500 through the end of November. One of the problems facing these managers has been poor market breadth. Market breadth is a measure indicating how many stocks are participating in a given move in an index. The recent advance in the S&P 500 has been largely driven by only a handful of stocks. Consider that just four stocks (Microsoft, Apple, Nvidia, and Google) have accounted for 70% of the index return over the last six months. Not owning those few companies driving the market, and in large position sizes, makes it very difficult to beat the passive benchmark. Better participation from a broader group of companies provides a healthier backdrop for active management. We would like to see this situation improve in 2022.

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6. Reasonable Alternatives to Fixed Income

Low-interest rates have made fixed-income investing very difficult for the last decade. Current yields for government bonds (ten-year treasuries) are 1.4%, a marked step down from the 2.8% annual return investors have earned over the last 10 years. Likewise, intermediate-term investment-grade corporate bonds are yielding only 2.4% compared to 4.7% ten-year annual returns. With diminished prospects, it is no wonder many investors are holding more equity in their balanced portfolios than ever before. In a recent analysis by Wells Fargo of individual household holdings in stocks (see Figure 6 below), the percentage of total assets is at an all-time high. Lower returns aside, fixed income still holds a valuable spot in client portfolios to offset the volatility and risk in equities. Given the lower expected returns from bonds, Boston Financial Management is exploring additional opportunities and strategies to diversify balanced portfolios to mitigate future risk.

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7. A Rookie Quarterback Winning the Super Bowl

In the history of the NFL, no rookie quarterback has ever won a Super Bowl. More than that, no rookie quarterback has ever even made the Super Bowl. We hope that changes this year. Mac Jones and the New England Patriots currently sit at the top of the AFC East standings. It is a long road to a title still, but this is worth asking for. The Patriots last won a Super Bowl in 2019, a long drought by this Patriot’s dynasty standards.

8. Happy and Healthy New Year

It has been a trying two years. Wishing you and your family health and happiness may sound trite, but seems more poignant than ever this holiday season. All of us at Boston Financial Management sincerely wish you a very happy holiday season.

The team at Boston Financial Management is always available to answer your questions. Please do not hesitate to contact your Wealth Manager directly or call our main line at 617-338-8108. We look forward to getting together in person in the new year!

Financial Pages Disclaimer:

This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.

Professional Designation Minimum Requirements Disclosure:

CFA® – Chartered Financial Analyst. Minimum requirements for the CFA® designation include an undergraduate degree and four years of professional experience involving investment decision-making, in addition to successful completion of each of the three CFA level examinations.