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What a Hawkish Fed Means to the 2022 Equity Outlook
Stocks stumbled into the New Year with the Federal Reserve’s plans to raise interest rates. Director of Quantitative Strategies Michael Hunstad, Ph.D., forecasts what to expect from equities in 2022 and how investors can prepare.
Last week's release of the December Federal Reserve meeting minutes sparked concern about the prospects of near term interest rate hikes. While equity prices dropped on the release, historically stocks have performed well when the Fed turns hawkish and starts to increase rates. We expect modest positive equity returns this year, but investors should prepare for bouts of volatility and focus on stable high quality companies with strong fundamentals. Let's take a closer look.
With higher inflation and the economy nearing full employment, investors expect the Federal Reserve to take a more hawkish stance in 2022. The December FOMC minutes indicated a higher probability of an interest rate hike at the March meeting and more later in the year. Importantly, during six of the last seven cycles of rising rates, stocks have posted positive returns following the start of the rate hike. The sole exception was the largest of the rate moves, a 325-basis point increase that began in 2004, a magnitude that far exceeds our expectations for 2022.
While we're cautiously optimistic about equities, we recognize there will be winners and losers. Companies with stronger financials and lower multiples are better positioned to weather the volatility around higher rates. These value-oriented higher quality stocks perform very well in 2021 as inflation expectations spiked. We expect that outperformance to continue into 2022. With capitalization weighted benchmarks still dominated by expensive growth companies, we think investors should consider cheaper higher quality segments of the market.
In 2022, investors should plan to navigate markets nimbly as we think the double digit benchmark returns of 2021 are a thing of the past. In the face of higher inflation and the Fed's more hawkish stance, investors must reevaluate risk and focus on fundamentals. Positioning into higher quality value-oriented equities will increase the chances that you get paid for the risk that you take in the year ahead.