- Markets and the economy have experienced ups and downs in the first half of the Biden administration’s first term.
- After some legislative success in 2021, the president’s agenda has stalled on Capitol Hill in 2022.
- What’s still on the agenda and how could it impact the markets?
With midterm elections coming in November 2022, we’re closing in on the halfway point of the first term for President Joe Biden. In that time, markets and the economy experienced distinctly different environments.
In 2021, the stock and bond markets generated solid performance. The U.S. economy enjoyed its strongest year of growth since 1984. President Biden also achieved a degree of success in pushing important pieces of his legislative agenda through Congress. However, inflation began to emerge as an issue. In 2022, a marked change occurred. The U.S. economy slowed significantly as inflation became an even more serious challenge. Stocks and bonds both generated losses in the first half of the year.
In his first year in office, President Biden was successful at implementing some, but not all, of his legislative initiatives. Several key bills are likely to be considered yet in 2022. What is the potential impact on the markets? Investment strategists from U.S. Bank Wealth Management offer an assessment of how the markets have fared so far under the Biden administration and what to expect going forward.
A change in direction
The arrival of the new Biden administration along with Democrats assuming narrow majorities in the House and Senate in 2021 marked a major change in Washington. A number of new policy proposals were laid out early in the term and began to work their way through the Congressional process.
In the first months of the new administration, Congress managed to narrowly pass President Biden’s $1.9 trillion COVID relief package, the American Rescue Plan. It included direct payments of up to $1,400 to most Americans, an extension of enhanced unemployment benefits, one year of direct payments to families with children and additional financial support for hard-hit businesses.
Later in the year, a $1.2 trillion infrastructure investment package passed through Congress and was signed into law. This included $550 billion in new spending above baseline amounts that were expected to already be in place under current budgets. Most of the funding is concentrated in transportation-related projects, with some directed toward water and power projects.
A stalled agenda in 2022
Other legislative initiatives pursued by the Biden administration remain on the table, but by mid-year, no major bills had been signed into law. Legislation under consideration includes:
- Build Back Better plan. This is a package of legislation that evolved throughout 2021 and 2022, starting out with a price tag of more than $3 trillion, eventually being cut back to a much less ambitious plan. It would provide for a series of new social spending programs, a proposal to reduce prescription drug costs as well as an emphasis on clean energy projects designed to combat climate change. Efforts to pass some form of this plan have yet to succeed in the Senate.
- Tax law changes. Congress was also considering a range of proposals from the Biden administration and members of the House and Senate that would alter tax policy, with a particular impact on higher income Americans and corporations. To date, limited progress has been made on pushing new legislation through. However, this could remain a major focus in the coming months and years since a number of provisions in the last major piece of tax legislation, the Tax Cut and Jobs Act of 2017, expire at the end of 2025.
- Retirement plan legislation. Various bills are under consideration in the Senate after the House passed, by a large, bi-partisan majority, the SECURE Act 2.0. Provisions in the legislation would enhance retirement savings opportunities and give most individuals more flexibility in how they manage their retirement savings. The Senate is now considering similar legislation and a package may be finalized before the November 2022 mid-term elections.
Interest rates and the economy
The Federal Reserve (the Fed) shifted its priorities from an emphasis on keeping the economy growing (based on its policies in 2020 and 2021) to trying to slow the inflation rate, which suddenly surged in 2021 and 2022. Until March 2022, the Fed held to a so-called zero interest rate policy on its short-term federal funds rate. The Fed also maintained a policy of purchasing $120 billion in Treasury and mortgage-backed securities each month as a way to help add liquidity to the markets and maintain lower, long-term interest rates. The Fed’s “easy money” stance proved to be a boon for the investment markets. “Low interest rates and a policy of buying Treasury and mortgage bonds were a big support for investors,” says Rob Haworth, senior investment strategy director at U.S. Bank.
However, as elevated inflation rates remained persistent, the Fed changed course in early 2022. It began to raise the fed funds interest rate significantly, ended its bond buying program and even began to reduce its holdings in the bond market. This shift in Fed policy is designed to temper the inflation threat but could also slow economic growth and have an impact on investment markets.
For all of 2021, the U.S. economy, as measured by Gross Domestic Product (GDP), grew by 5.7%, according to the U.S. Bureau of Economic Analysis. That was the strongest year of growth since 1984, though it came on the heels of GDP growth of -3.4% in 2020. The Fed’s policy shift is likely to change the economic environment.
“If the Fed continues to tighten monetary policy (by raising interest rates and removing liquidity from the bond markets) to the point that inflation falls, it follows that we’re likely to see a decline in economic growth,” says Eric Freedman, chief investment officer at U.S. Bank.
The market’s response
The markets benefited from a strong economy in 2021, the first year of the Biden administration. A healthy economy kept corporate profit growth, a major driver of stock price activity, moving in a positive direction throughout the year. 2022 saw both stock and bond markets struggle in the first half of the year.
It’s important to note that a number of factors contribute to market performance, and it’s not strictly a reflection of the individuals who wield positions of power in Washington. “What mostly drove stock prices higher in 2021 is the actual rise in corporate earnings,” says Haworth. In 2022, it’s been a different story as ongoing inflation concerns, the Fed’s policy change and Russia’s invasion of Ukraine became factors that affected the stock market. As a result, stocks declined significantly in the first half of 2022, with the benchmark Standard & Poor’s 500 Index falling into a bear market (a decline of more 20% from the market’s peak) in June.
Bond markets began to face pressure late in 2021 as the Fed’s policy stance shifted. Yields on the benchmark 10-year U.S. Treasury note, which were below 1% at the outset of 2021, started moving higher by the end of the year. Note that bond values decline as interest rates rise. With the Fed raising short-term interest rates and reducing its level of participation in the bond market, yields in the broader bond market moved significantly higher in the first half of 2022.
Positioning portfolios today
Regardless of policy initiatives that are put forward in 2022, it’s important to keep a big-picture perspective.
U.S. Bank Wealth Management investment strategists anticipate slower economic growth and tighter Fed monetary policy this year, which may result in a challenging environment for asset prices.
“If the Fed continues to tighten monetary policy to the point that inflation falls, it follows that we’re likely to see a decline in economic growth.”
-Eric Freedman, chief investment officer at U.S. Bank
Depending on one’s goals and time horizon, today’s investor might consider:
- An overweight position in real assets, with an emphasis on utilities, transportation, communications, midstream energy and pipelines. Economic reopening, recovering supply chains and underinvestment in energy distribution offer attractive fundamental underpinnings to a category that also provides diversified cash flows from traditional equity and fixed income.
- An overweight position in fixed income, focused on high-quality investment grade taxable and municipal bonds and dedicated exposure to short-term U.S. Treasury investments to manage risk exposure if interest rates should continue to rise.
- An underweight position in equities in both large-cap U.S. and foreign developed stocks. Continued Fed interest rate hikes, which are anticipated, could put pressure on equity markets for an extended period of time.
Regardless of how events play out, we think maintaining a properly diversified portfolio that is attuned to your specific comfort level with investment risk is a sound strategy.
Have questions about the economy, the markets and your finances? Your U.S. Bank Wealth Management team is here to help.
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