Tempered But Optimistic Enthusiasm Over Stocks

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As the stock market recovered from the 2020 pandemic lows, valuations reached levels not seen since the dotcom bubble more than 20 years ago. The reopening economy and massive fiscal stimulus helped fuel one of the strongest starts to a bull market ever (a bull market that just turned two-years-old last week). Low interest rates were a big part of the story. But just as low interest rates helped support stock valuations, that relationship can go in reverse as we’ve witnessed recently.

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Ready, Set, Rate Hike

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The Federal Reserve (Fed) meets this week and in all likelihood will raise short-term interest rates for the first time since emergency levels of monetary accommodation were provided to markets after the COVID-19 shutdowns. Inflationary pressures are running higher than the central bankers are comfortable with, but the conflict in Eastern Europe adds to the uncertain path of policy normalization. Prospects of yield curve inversion make the Fed’s job trickier.

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Are Core Bonds Under Pressure

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Core bond investors have experienced one of the worst starts to the year ever, potentially calling into question the validity of bonds in a portfolio. Despite the poor start, we don’t think the value proposition for bonds has changed much. Moreover, with yields on most fixed income markets moving sharply higher, now could be a good time to revisit fixed income markets. Starting yields are still the best expectation of future returns and have become more attractive in a number of markets recently.

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Downshift in U.S. Market Growth But Still Above Expectations

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We currently expect the U.S. economy to grow 3.7% in 2022. The risks are to the downside since the Fed may err on tightening too fast, the recent commodity spike may trickle down to the U.S. consumer, and supply and demand imbalances may last longer than expected. This forecast is lowered from our previous 4-4.5% range originally published in Outlook 2022: Passing the Baton. The rest of this commentary explains the overall themes supporting the forecast.

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