The State of the Stock Market: A Year in Review and a Look Ahead

The U.S. stock market has been on a roller coaster ride this year, as investors grappled with the impact of the coronavirus pandemic, rising inflation, supply chain bottlenecks, and geopolitical uncertainties. The market reached new all-time highs in August and September, but also suffered sharp corrections in January, March, May, and October. The S&P 500, the benchmark index for U.S. stocks, is up about 15% year-to-date, while the Dow Jones Industrial Average and the Nasdaq Composite are up about 12% and 18%, respectively.

Some of the main factors that influenced the market performance this year are:

The pandemic and the vaccine rollout: The global health crisis caused by the novel coronavirus disrupted economic activity, consumer spending, and corporate earnings in 2020 and 2021. The U.S. economy contracted by 3.5% in 2020, the worst performance since 1946. However, the development and distribution of effective vaccines boosted market optimism and led to a strong recovery in the first half of 2021. The U.S. economy grew by 6.3% in the first quarter and 6.7% in the second quarter of 2021. However, the emergence of new variants of the virus, such as the Delta variant, posed new challenges and risks for the recovery. The U.S. reported over 100,000 new cases per day in August and September, prompting some states to reimpose mask mandates and social distancing measures. The vaccine rollout also faced some hurdles, such as vaccine hesitancy, supply shortages, and regulatory delays. As of October 22, 2021, about 67% of the U.S. population had received at least one dose of a vaccine, and about 57% were fully vaccinated.
Inflation and monetary policy: The rebound in economic activity and consumer demand, coupled with supply chain disruptions and labor shortages, led to a surge in inflation in 2021. The consumer price index (CPI), a measure of inflation, rose by 5.4% year-over-year in September, the highest level since 2008. The core CPI, which excludes food and energy prices, rose by 4% year-over-year in September, the highest level since 1991. The Federal Reserve, the central bank of the U.S., has maintained that inflation is largely transitory and reflects temporary factors related to the reopening of the economy. The Fed has kept its key interest rate near zero and its monthly bond purchases at $120 billion since March 2020 to support the recovery. However, some market participants have expressed concerns that inflation may prove to be more persistent and force the Fed to tighten its monetary policy sooner than expected. The Fed has signaled that it may start tapering its bond purchases as soon as November and raise its interest rate as early as next year.
Geopolitical tensions: The U.S. stock market has also been affected by various geopolitical events and conflicts around the world. One of the most prominent issues has been the trade and technology rivalry between the U.S. and China, which escalated under the Trump administration and continued under the Biden administration. The two countries have imposed tariffs and sanctions on each other's goods and entities over issues such as intellectual property rights, human rights, cybersecurity, and national security. The U.S. has also banned or restricted several Chinese companies from accessing its markets or technologies, such as Huawei, TikTok, WeChat, Alibaba, Tencent, and Didi. The tensions have created uncertainty and volatility for both U.S. and Chinese companies and investors. Another major geopolitical event that rattled the markets was the withdrawal of U.S. troops from Afghanistan in August, which resulted in a swift takeover by the Taliban. The chaotic exit raised questions about the credibility and leadership of the U.S. in global affairs.

What are the expectations for the next year?

Looking ahead to 2022, there are several factors that may shape the outlook for the U.S. stock market:

The pandemic and the vaccine booster shots: The trajectory of the pandemic and the effectiveness of the vaccines will remain key drivers of the market sentiment and the economic recovery. The U.S. has recently approved booster shots for some groups of people who have received the Pfizer or Moderna vaccines, such as those who are 65 or older, have underlying medical conditions, or work in high-risk settings. The booster shots are expected to enhance the protection against the virus and its variants, especially the Delta variant, which is more contagious and virulent than the original strain. However, the availability and accessibility of the booster shots may vary across states and regions, depending on the supply and demand. The U.S. may also face challenges in convincing some people to get their first or second doses of the vaccine, let alone the booster shots. The U.S. may also need to coordinate with other countries and international organizations to ensure a fair and equitable distribution of the vaccines globally, as the pandemic is not over until it is over everywhere.
Inflation and fiscal policy: The inflation outlook and the fiscal policy stance will also have a significant impact on the market performance and the monetary policy decisions. The inflation rate may moderate in the coming months as some of the supply chain bottlenecks and labor shortages ease, but it may also remain elevated for longer than expected if some of the price pressures become more entrenched or widespread. The fiscal policy may also influence the inflation dynamics, depending on the size and composition of the government spending and taxation plans. The Biden administration has proposed two major spending packages: a $1.2 trillion bipartisan infrastructure bill and a $3.5 trillion social spending and climate bill. The infrastructure bill has passed the Senate and awaits a vote in the House, while the social spending bill faces opposition from some moderate Democrats who want to reduce its cost and scope. The passage of these bills may boost economic growth and job creation, but also add to the fiscal deficit and debt, which may have implications for inflation and interest rates.
Geopolitical risks: The U.S. stock market may also be influenced by various geopolitical risks and uncertainties that may arise or escalate in 2022. Some of the potential flashpoints include:
- The U.S.-China relations: The U.S. and China may continue to clash over trade, technology, human rights, Taiwan, Hong Kong, Xinjiang, South China Sea, and other issues. The two countries may also compete for influence and leadership in regional and global forums, such as the United Nations, the World Trade Organization, the World Health Organization, and the Group of 20. The U.S. and China may also cooperate on some common challenges, such as climate change, nuclear proliferation, and pandemic response, but their cooperation may be limited or conditional.
- The Iran nuclear deal: The U.S. and Iran may resume negotiations over reviving the 2015 nuclear deal, which was abandoned by the Trump administration in 2018. The deal aimed to limit Iran's nuclear activities in exchange for sanctions relief from the U.S. and other world powers. However, the talks have stalled since June, as both sides have hardened their positions and demanded more concessions from each other. Iran has also accelerated its uranium enrichment activities in violation of the deal. The U.S. has also imposed new sanctions on Iran over its alleged involvement in a drone attack on an Israeli-linked oil tanker in July. The prospects for a diplomatic breakthrough remain uncertain and fragile.
- The North Korea nuclear threat: North Korea may pose a renewed threat to regional and global security, as it has resumed its missile tests after a hiatus of more than a year. North Korea has tested several new weapons systems this year, including a hypersonic missile, a submarine-launched ballistic missile, a long-range cruise missile, and a short-range ballistic missile. North Korea has also rejected any dialogue with the U.S., unless it drops its "hostile policy" toward Pyongyang. The U.S. has expressed its willingness to engage with North Korea diplomatically, but has also reaffirmed its commitment to defend its allies South Korea and Japan from any provocation.

The U.S. stock market may face more volatility and uncertainty in 2022, as it navigates through these complex and dynamic factors. However, it may also find some opportunities and catalysts for growth and innovation, as it adapts to the changing environment and embraces new technologies and trends.

Additional Reading Some possible sources for additional reading are: