Buying U.S. stocks could be a superior way to gain international exposure

Smart investors balance their portfolios between domestic and international financial investments. However, what might not be obvious when selecting stocks is that often investments in domestic companies come with significant international exposure.

“Most investors I speak with unwittingly have way too much international exposure,” says Sam Kendrick, portfolio manager and vice president at Whittier Trust Company. 

Due to globalization over the last 50 years, U.S. companies have been investing more and more overseas, and the amount of international exposure in the S&P 500 has gone up over time. “Around 40% of domestic large cap company revenues come from outside of the U.S. so you’re actually getting a really nice amount of international exposure when you buy the S&P 500,” he says.

Here, Kendrick explains why you get a superior form of—and enough—international investments when buying U.S. stocks.

It’s Less Risky

When you invest in a domestic company that has invested abroad, there’s more oversight at a micro level. “You get U.S. accounting standards, U.S. auditors reviewing the financial statements and the SEC monitoring the buying and selling of the stock,” says Kendrick. “If I just buy Chinese stock in a Chinese company and they said they made $100 million dollars last year, I’m less sure that’s true. Whereas in the U.S., you can be more confident here than elsewhere that they made that money.”

On a larger level, by investing domestically, your investment is being domiciled in a large, stable, democratic country with stocks that trades in dollars, which is the reserve currency of the world. “There is less risk because in times of crisis, investors across the world seek dollar denominated exposure. Because our economy is large and resilient, investors want to own companies with the majority of their revenue generated here rather than from countries that are less stable,” Kendrick says.

It's More Diversified and Less Cyclical

The U.S. stock market is extremely well diversified in a few different ways. For starters, the S&P 500 gets 60% of its revenues from the U.S., 14% from Europe, 7.4% from China and 3% from Japan, according to Factset

“Then from a sector perspective, there are very robust allocations within the S&P 500 to healthcare, technology, communications and industrials. All of these sectors have large, high-quality companies with differentiated products,” says Kendrick. More commoditized sectors, such as energy, materials, financials and real estate, have a relatively low exposure in the S&P 500 compared to foreign markets.

On top of that diversification, Kendrick notes that the S&P 500 is less cyclical than foreign indexes, meaning it encompasses more companies that are less dependent on the economic cycle to grow. According to JP Morgan, 34% of the S&P 500’s exposure is to cyclical sectors, whereas emerging markets’ exposure is 49%, Europe’s is 53% and Japan’s is 57%.

“All else being equal, it’s better to invest in companies that have less volatility in their revenue and earnings growth,” Kendrick says.

It Has the Cheapest Cost of Capital

Kendrick often speaks with investors who are hesitant to allocate more money to domestic stocks because they are more expensive than foreign stocks. However, the other side of the coin is that the expensive price tag reflects a cheaper cost of capital for U.S. companies. 

“Higher valuations mean that U.S. companies can raise money more cheaply. This means large U.S. companies can raise capital and buy foreign assets rather than selling their assets to foreign firms,” says Kendrick. “When it comes to small companies, entrepreneurs, venture capital firms and private equity firms focus on the U.S. because of the higher valuations businesses receive here versus abroad. In turn, having many of the most successful startups based in the U.S. increases our country’s growth rate.” 

He cites Tesla as an example of cheap capital driving U.S. growth. “Despite not being profitable for 17 years, U.S. markets provided the funds it needed to grow. Now it has reached scale and is raising debt and equity in U.S. markets to expand overseas with large factories in Germany and China,” Kendrick says. “It’s hard to imagine the same growth story taking place in another country.” 

When thinking about your portfolio and buying domestic vs. international stocks, consider the above three reasons to buy U.S. over international. Also, consider this: giving up some outperformance in a bull market is ok if the downside protection is better. “Everyone focuses on how U.S. markets have outperformed since the global financial crisis, but the truth is, even if U.S. and international were expected to perform the same, we would still buy U.S. because it’s less risky,” Kendrick says. 

The right kind of insurance can mitigate tax exposure and maximize legacy-building

No matter the length of your balance sheet, preserving the wealth means being smart about how your investments are structured to minimize tax exposure, both in life and as you look to pass wealth on to the next generation.  Some of the best investments for tax efficiency might be a specialized kind of insurance. 

“Private Placement Life Insurance (PPLI) policies have existed for quite some time and have become increasingly popular with wealthy individuals seeking to mitigate tax exposure,” says Whittier Trust Assistant Vice President for Client Advisory Shea O’Gara, J.D. “PPLI policies provide a unique solution for holding tax inefficient investments while maximizing intergenerational transfers of wealth.” Generally, PPLI is most suitable for accredited investors including high net worth individuals, banks, brokers, and trusts. 

PPLI attempts to couple the tax advantages of Variable Universal Life Insurance (VUL) with the growth often associated with alternative investments. This renewed interest in PPLI is largely being driven by wealthy individuals in top tax brackets, with good reason. For instance, in certain circumstances top earners in California and New York can face a combined federal and state income tax rate in excess of 50%. Additionally, assets above the federal estate tax exemption can be subject to a 40% death tax. When structured appropriately, PPLI can mitigate both income and estate tax exposure.

“While a PPLI does offer some estate planning opportunities, the main focus is to capitalize on the tax-free treatment of income and gains produced within the policy,” O’Gara says. Because PPLI incurs no immediate income tax, there is no need to wait for a Schedule K-1 to report the incomes, losses and dividends of a partnership

“PPLI stands in contrast to traditional life insurance policies in many ways, but perhaps most notably it provides an opportunity for the insured to hold non-traditional investment positions,” O’Gara explains. For example, a PPLI policy can consist of private equity, hedge funds, private credit and other alternative investments otherwise not accessible in a traditional life insurance policy. The policy usually contains a high cash balance affixed with a lower death benefit to reduce ownership costs. Although insurance costs vary when owning a PPLI, the long-term tax savings usually greatly exceed the policy cost.

A PPLI operates as an income tax mitigation strategy, but it can also serve as an estate tax strategy if structured properly. Ideally, the policy would be owned outside an individual’s taxable estate through an irrevocable trust. When the PPLI is owned by an irrevocable trust, the death benefit passes estate tax free. If an individual has yet to utilize their lifetime gift exemption, owning a PPLI in an irrevocable trust is a potential option. It can be a smart addition to an overall wealth management strategy, executed by a trusted wealth management advisor. 

Notwithstanding a multitude of advantages associated with a PPLI, there are some drawbacks to consider. Mainly, (1) medical underwriting, (2) lack of control, (3) costs and (4) early surrender consequences. 

  1. The individual insured must be in good health and willing to undergo a comprehensive review of medical records and insurance exam. 
  2. An IRS investor control rule stipulates that the policy holder cannot influence the selection of individual securities held within the policy either directly or indirectly. However, policy owners dictate which funds their policy owns.
  3. Costs vary, but generally PPLI fees include a structuring fee, federal deferred acquisition cost tax, state premium tax, asset-based mortality expense charges, and cost of insurance charges. Initially, PPLI policies are fee intensive and in the short term could exceed the immediate tax benefits. 
  4. Generally, there is no fee associated with surrendering the policy. However, tax may be owed on the appreciation of investments at an ordinary income tax rate.

PPLI is a nuanced solution that can be beneficial to high net worth individuals. PPLI requires a thorough analysis to determine if such a strategy is beneficial due to its complexity.  

Foreign Contagion Risks and the Policy Path 

The U.S. economy continues to show remarkable resilience in the face of stubbornly high inflation and tighter financial conditions. Core inflation, which is more influenced by the sticky components of rents and wages, remains elevated even as headline inflation recedes at a glacial pace. The Fed has already raised short rates from zero to 3% and remains steadfast in its commitment to more rate hikes.

The fallout from persistent inflation and a hawkish Fed has led to several adverse outcomes. The U.S. dollar and long-term bond yields continue to soar higher. And stock prices continue their downward trajectory as they discount rising risks of a global recession.

Despite the Fed’s efforts to cool the economy down, the jobs market remains surprisingly strong. The unemployment rate is still at its all-time low of 3.5% and weekly unemployment claims are close to historical lows. There are still 10 million job openings, which far exceed the available pool of 6 million unemployed workers.

Healthy job creation and steady wage gains have supported consumer incomes and spending. As a result, real GDP growth for the third quarter is projected to rebound from negative levels in the first two quarters to above +2%.

On the policy front, the Fed has repeatedly communicated that restoring price stability now is crucial for achieving sustainable growth and full employment in the long run. In this context, the Fed has made it abundantly clear that it is willing to accept “short-term pain for long-term gain”.

The current economic backdrop in the U.S. will likely encourage the Fed to continue tightening aggressively. After all, why worry about the possibility of breaking something in a big way or unleashing systemic risk from a financial crisis when we haven’t even slowed the economy materially?

With investor focus squarely on U.S. inflation and Fed policy, it may be worthwhile at this juncture to take a closer look at the broad global economic landscape. The U.S. has enjoyed strong growth fundamentals through both the Covid crisis and this latest inflation shock. The rest of the world has not been so fortunate. The inflation problem is significantly worse and growth is materially weaker outside the U.S.

In a still tightly integrated global economy, we examine the impact of U.S. policy actions on global growth. To what extent has the rapid pace of Fed tightening contributed to global economic stress?

At a more relevant level, we also assess the risks of contagion back to the U.S. from ailing foreign economies. We focus on two themes:

  • Can the U.S. remain an oasis in an increasingly barren global growth landscape and avoid cross-border contagion?
  • Can U.S. policy responses better mitigate global systemic risk and minimize contagion risks?

We look at recent developments in key foreign economies. We identify the strong dollar as a potential driver of future U.S. and global weakness. Finally, we offer some thoughts on the Fed’s optimal policy path forward within a broader global context.

Foreign Economic Risks

We begin our brief tour of foreign economies with a quick look at recent volatility in the U.K. bond market and its global fallout.

On September 23, the new administration in the U.K. announced a new fiscal plan to spur growth from supply-side reform and tax cuts. However, this focus on fiscal stimulus was at odds with restrictive monetary policy from the Bank of England and risked a further escalation of already-high inflation.

The lack of any funding details also raised concerns about an unsustainably higher debt burden and sent U.K. bond yields soaring. This upward spiral in bond yields was further exacerbated by forced liquidation of U.K. long-term bonds, also known as gilts, by local pension funds.

The unexpected rise in U.K. bond yields spread through the global bond and currency markets. This contagion is seen clearly in Figure 1.

Source: FactSet as of October 12, 2022

Immediately after the initial announcement, the 30-year U.K. gilt bond yield (shown in green) rose by more than 100 basis points to almost 5%. The spike in U.K bond yields reverberated across the globe. The 10-year U.S. bond yield (dark blue) moved higher by 50 basis points to almost 4% and the U.S. dollar strengthened against the British pound (light blue) by more than 5%. Higher bond yields and the strong dollar, in turn, sent U.S. stocks significantly lower at the end of September.

The rise in U.K. bond interest rates also highlighted another vulnerability for the global economy. As much as higher interest rates crowd out consumer spending in any economy, the problem is particularly severe in foreign economies.

The U.S. consumer is unique, and fortunate, in being able to access fixed rate long-term mortgages ranging in term from 15 to 30 years. For example, think about a U.S. household that refinanced its long-term mortgage during the period of low interest rates prior to 2022. With a low interest rate locked in for many years, that household is now immune to higher housing costs from rising mortgage rates.

Our readers may find it interesting to note that few mortgages overseas are at a fixed rate over long terms. Figure 2 provides a glimpse of how mortgages vary across countries by the term over which the interest rate is fixed.

Source: European Mortgage Federation

More than 90% of mortgages in the U.S. have a fixed rate over a long term in excess of 10 years. In Germany and Spain, that proportion drops to just around 50%. The impact of rising rates on housing costs is even worse in the U.K., where long-term fixed rate mortgages simply don’t exist.

More than 90% of mortgages in the U.K. offer a fixed rate for only 1-5 years. In a country already hit hard by high inflation, the greater proportion of mortgages resetting to a higher rate and higher payments significantly add to the odds of a U.K. recession.

The situation is also grim in Europe, but for a different set of reasons. Europe’s historical dependence on Russian energy is well known. Prior to the war with Ukraine, roughly 40% of Europe’s natural gas imports came from Russia. Since the invasion, Europe has looked for new sources of supply and Russia has retaliated by shutting off some of its existing supply of gas.

The resulting energy shortfall in Europe has led to sky-high energy prices, high inflation and significantly weaker growth. We show the outsized impact of energy costs on Eurozone inflation in Figure 3.

Source: European Central Bank

The nearly ten-fold increase in natural gas prices in Europe has led to a mega-spike in energy inflation and double-digit headline inflation in Europe. While energy inflation in the U.S. has started to decline, it shows no signs of abating in Europe. And things are likely to get worse during the dark winter months as Europe contemplates reduced energy consumption. Any cutbacks in production within energy-intensive sectors will likely lead to more layoffs and lower economic growth.

European policymakers are particularly hamstrung in balancing inflation and growth considerations at this point. The inflation problem in Europe emanates from a true supply shock, which cannot be remedied simply by raising interest rates. Any fiscal stimulus to counter lower industrial production and employment runs the risk of driving already-high inflation even higher.

Our baseline outcomes for Europe are listed below.

  • The European Central Bank is unlikely to hike rates as aggressively as the Fed.
  • A weak Euro will likely contribute to higher energy prices and more persistent headline inflation.
  • Europe may be forced to consider fiscal stimulus at some point to soften the recessionary hit.

Finally, we touch briefly on growth challenges in China. For a long time, China’s high growth trajectory was achieved by investment and trade. It has recently tried to shift growth more towards domestic consumption, but with limited success. China’s two key drivers of growth are now under significant pressure.

China’s investment share of GDP is almost twice the global average and has come at the expense of an unsustainable surge in debt. As an example, the heavily indebted real estate sector is now slowing dramatically. A zero-Covid policy has reduced mobility of people, goods and services, increased supply chain problems and decreased global trade. China’s trade and competitiveness have been further compromised by the new U.S. export controls on semiconductor chips and machinery.

We note in summary that foreign economies are far more fragile than the U.S. and remain quite vulnerable to policy missteps and exogenous shocks.

Pitfalls of a Strong Dollar

The U.S. economy is stronger than any foreign economy for a number of reasons. The recent monetary and fiscal stimulus in the U.S. was the largest in the world. As a result, the U.S. consumer is still resilient and its jobs market is still strong. U.S. inflation is, therefore, as much a demand issue as it is a supply-side shock.

As we have discussed above, this is not the case in the rest of the world. Foreign central banks are unable to raise rates aggressively because of weaker demand. Foreign inflation is also far less of a demand issue than it is a true supply-side shock.

This divergence between growth and policy dynamics in the U.S. and the rest of the world argues for continued dollar strength. We highlight two key risks from a persistently strong U.S. dollar.

First, a strong dollar reduces earnings for U.S. multinational companies from a simple currency translation effect. Revenues booked in foreign countries get translated back to lower dollar levels at a higher exchange rate. Figure 4 shows this intuitive strong-dollar / weak-earnings relationship.

Source: Bloomberg

The blue line in Figure 4 shows the year-over-year change in the U.S. dollar on an inverted scale on the right axis. A downward sloping line, therefore, denotes dollar strength. The green line shows the year-over-year growth in S&P 500 earnings estimates for the next twelve months (NTM) on the left axis.

We can clearly see here that S&P 500 earnings go down as the dollar goes up. A sustained rally in the U.S. dollar going forward could further reduce corporate profits and potentially trigger a dangerous self-reinforcing spiral of more layoffs, lower consumer spending, weaker economic growth, lower company revenues, back to lower profits … and so on.

And second, a strong dollar poses risks to foreign economies as well. A strong U.S. dollar raises the cost of their imports and drives up their inflation. Supply-side energy inflation is already high overseas; a strong dollar only makes this bad situation worse. Currency fluctuations affect trade balances and foreign exchange reserves. And emerging market economies find it increasingly difficult to service their dollar-denominated debt.

The strength of the U.S. dollar remains an important conduit for global contagion of economic weakness.

Possibilities for the Policy Path

The Fed has repeatedly reiterated its relentless pursuit of monetary tightening to quell inflation. It has so far been unmoved by the prospects of a U.S. or global recession.

We have recently suggested that the Fed may be well served from a shift in positioning where it becomes less rigid and more data-dependent. Our view is based on the observation that real-time U.S. inflation is likely coming down even as lagged measures of inflation such as shelter CPI continue to rise. We believe that the downward trajectory in upstream and coincident inflation will eventually bring overall inflation below policy rates.

Our focus on the fragility of foreign economies bolsters the argument for a more flexible approach to Fed policy. There is now an increasing chance that a central bank or government misstep is an accident waiting to happen. The calamitous fallout from the U.K. mini-budget crisis is just one small example.

We also believe that it is premature for the Fed to pause right now and a grave mistake for it to pivot towards rate cuts. We support the notion of continued rate hikes in 2022 to keep inflation expectations in check.

However, the Fed will likely have done enough and the U.S. and global economies will likely have weakened enough for the Fed to signal a pause in early 2023. A prescriptive upward march in U.S. policy rates in 2023 may very well lead to an unexpected and dire financial crisis somewhere in the world.


We are still in the midst of unprecedented economic and market uncertainty. U.S. core inflation remains sticky even as more timely measures of inflation appear to be declining in real time. Foreign inflation is less influenced by demand and largely remains a supply-side shock.

Against this backdrop, foreign economies are fragile and especially vulnerable to policy missteps. We believe that a pause in rate hikes by the Fed in 2023 will mitigate the risks of unexpected financial crises.

We continue to emphasize our strong regional preference for the U.S. over foreign markets. We also continue to target sufficient liquidity reserves to help our clients weather this storm. More so than ever, we remain vigilant and prudent in diversifying risk within client portfolios.


Foreign economies are fragile and remain vulnerable to policy missteps and exogenous shocks.


The strength of the U.S. dollar remains an important conduit for global contagion of economic weakness.


A pause in rate hikes by the Fed in 2023 will mitigate the risks of unexpected financial crises.

From Investments to Family Office to Trustee Services and more, we are your single-source solution.

An image of a silver and gold ring intertwined together.

Navigating deferral of gain on QSBS

When you’re growing a legacy, it’s only natural to want to preserve as much of your hard-earned wealth as possible. From exploring the best investment options to the tax efficient funds that suit your overall goals and much more, prudent financial advisors make it a priority to consider any and all options for their clients. For those who own their own businesses, corporate tax structure is of particular interest. 

Case in point: one side-effect of the 2017 Tax Cuts and Jobs Act (TCJA) was the renewed interest in Qualified Small Business Stock (QSBS). “With the corporate tax rate reduced from 35% to 21%, business founders, investors, private equity groups and hedge funds have increasingly turned to QSBS as a way to save millions in taxes,” says Client Advisory and Tax Vice President at Whittier Trust Charles Horn, who looks to maximize wealth retention and growth for his clients. 

QSBS is codified in IRC section 1202 and was originally published in 1993 to encourage investment in emerging companies by providing income tax incentives to holders of such stock. QSBS can only be issued by a C-Corporation with a market cap equal to or less than $50M. The tax exclusion for each issuer of QSBS is the greater of $10M or 10 times the adjusted basis. For a corporation with an adjusted basis of $50M at the time of issuance, the tax exclusion could be as high as $500M. This could be a huge win for a small business owner. 

One important requirement of IRC section 1202 is that the stock must be held for more than five years from date of issuance. The general rule is that the five-year holding period begins when the stock is issued. “We’ve been asked to assist clients where QSBS stock held by a trust has not yet reached the five-year holding period and the underlying C-Corporation is being dissolved. Clients often wonder what if anything can be done in such an instance,” says Horn. “The answer is yes, so long as the stock has been held for at least six months.” This is where IRC section 1045 steps in.

IRC section 1045 allows a taxpayer to defer recognition of gain on the sale of QSBS if replacement stock is purchased within 60 days beginning on the date of sale. “In other words, so long as a taxpayer can identify a replacement QSBS stock within 60 days of the dissolution of the previous QSBS stock, the exclusion can still apply,” Horn explains. 

In fact, IRC section 1045 is more generous than IRC section 1031, which governs like-kind exchanges of real property. Under IRC section 1031, cash received from the sale of real property must be held by a qualified intermediary (“QI”) and cannot touch the hands of the taxpayer for one moment during the transaction. IRC section 1045 has no tracing restriction. “In fact, one could receive the funds from the sale of QSBS, use those funds for some other need, and use replacement funds to purchase new QSBS within 60 days and the rollover remains intact,” says Horn. 

The primary restrictions are that the taxpayer must reinvest the entire sales proceeds (not just gain) in replacement QSBS or gain recognition will be required and the replacement QSBS must meet the qualified trade or business requirement for at least 6 months after the taxpayer’s acquisition. Taxpayers must also make an election of deferral on a timely filed tax return for the year of sale.

In fact, even where newly acquired QSBS later fails the requirements of IRC section 1202 resulting in the recognition of capital gains, the deferral mechanism of IRC section 1045 will still apply. In other words, the deferral of tax under the IRC section 1045 remains intact even if a taxpayer is eventually forced to recognize gain. “IRC 1045 is a powerful tool and safety net for investors looking to take advantage of IRC 1202,” says Horn, who notes that taxpayers should consult their tax attorney or CPA with any questions.

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Pass-Through Scenario

Sep 27th

Our View

The Policy Path Ahead

It is rare to see two consecutive weekly declines of –5% in the stock market. We have unfortunately witnessed this negative outcome in the last two weeks. And sentiment remains bearish through this week as well.

We share some thoughts on the –11% decline in the S&P 500 index since September 12. We focus on 3 events that have catalyzed the most recent decline in stock prices – the August inflation report, the September Fed announcement and the surprise fiscal stimulus from the U.K. government.

The Fed

Markets were initially jolted when CPI inflation data for August surprised to the upside. On September 13, headline inflation came in at 8.3% instead of 8% and core inflation rose by 6.3% instead of 6%. Core inflation also showed a monthly gain of 0.6% instead of the consensus 0.3% expectation.

The higher-than-expected inflation data increased the odds of larger and more frequent rate hikes from the Fed. As much as investors may have geared up for a hawkish Fed, they were still taken aback by the tough Fed policy message on September 21.

The Fed projected that short term rates would rise to 4.4% by the end of 2022 and 4.6% by the end of 2023. And they expect their favored inflation metric to subside to almost 5.5% by year-end 2022, then to around 3% by 2023 and to just above 2% by 2024.

The Fed projections themselves were not too different from market expectations. For example, the market had priced in short rates of around 4.5% next year; the Fed was just a touch higher at 4.6%.

But what may have caught the markets by surprise was the Fed’s ultra-hawkish tone in continuing to fight inflation at any cost. The Fed essentially committed to an additional 150 basis points of rate hikes in the coming months without due regard to “data-dependency”. In the process, the Fed came across as prescriptive and mechanical as opposed to thoughtful and deliberate.

The U.K. Government

The new U.K. government announced a sweeping program of tax cuts and investment incentives on September 23 to boost the country’s faltering economic growth. However, the proposed plan set off several unintended consequences that now pose a greater risk to global markets.

A “loose fiscal, tight monetary” policy has historically led to weaker asset prices. The currency and bond markets in particular reacted violently to the misguided fiscal stimulus in the face of already rampant inflation.

The British pound declined sharply to record lows as investors worried about even higher inflation. The increase in the debt burden also sent long term bond yields to well above 4%.

The combination of the Fed’s hawkish posture and the U.K. fiscal plan sent the dollar soaring by 4%, the 2-year bond yield higher by 30 basis points and the 10-year bond yield climbing by 50 basis points to almost 4%.

The Outlook

The parabolic rise in the dollar and global interest rates create additional risks to the global economy. We assess them in the following framework.

  1. Given the growing evidence of a global slowdown and cooling inflation in the U.S., the Fed may now be approaching a stage of raising rates “too far too fast for too long”. We believe that a rigid and inflexible approach to continued tightening by the Fed may not be optimal.
  2. We advocate an impactful but yet measured and flexible policy path forward. We believe that inflation has peaked and is slowing down meaningfully to afford the Fed enough flexibility in the pace and frequency of future rate hikes.
  3. Our view on inflation peaking and now subsiding is supported by several metrics – copper, lumber, gasoline, house prices, mortgage rates, rents, tax receipts.
  4. Absent a shift in positioning, the risk of a Fed policy misstep is now higher. We believe it will eventually be avoided.
  5. We believe the sharp rise in long term U.S. bond yields is unsustainable especially in the face of declining inflation and demand destruction. Lower bond yields will likely help ease the strain on growth and valuations.
  6. Future rate hikes from the Fed will likely continue to slow growth and increase the magnitude and duration of a potential economic and earnings recession.
  7. The increased odds of a recession are already reflected in the new lows that have been created in the stock market this week.
  8. Unless the Fed blunders into a major mistake, we do not expect a deep and protracted recession or a lengthy bear market.
  9. We continue to hold existing equity exposure, slowly deploy un-invested cash into growth assets in public and private markets and explore ways to create tax alpha from tax loss harvesting.

These are extraordinary times of change, challenge and chaos. We stand ready to help you navigate this unusually high market volatility.

The End of Easy Money


The market turmoil in 2022 so far is in sharp contrast to the heady mix of stimulative policy and low volatility in 2021. In 2022, persistently high inflation has led to tighter monetary policy and slower growth.

The Fed has raised rates from 0 to 2.25%. It is on track to reduce its balance sheet ... perhaps by as much as $500 billion by December. Long term interest rates have moved dramatically in response to inflation and proposed Fed policy. Along the way, the war in Ukraine and lockdowns in China have further pushed back the potential peak in inflation.

These events have conspired to create a hostile market environment for risky assets. At their low point, stocks were down by more than -20% and bonds had declined by over -10%.

As a long cycle of easy money draws to an end, we discuss several implications of a more normalized regime of inflation, interest rates and valuations.

In the short term ...

  • Have we just seen that elusive peak in inflation or will the data “flatter to deceive”?
  • How far behind is the Fed in its tightening cycle and how far does it need to go from here?
  • Are we in a recession now? If not, when will it arrive and how long will it last?
  • How severe and protracted will the bear market be for stocks and other risky assets?

There are even more intriguing questions on the other side of this economic slowdown.

In the longer run ...

  • Where will inflation and interest rates eventually settle?
  • What will stock and bond returns look like?

These are extraordinary times of change, challenge and chaos. We hope these insights help our readers navigate this unusually high market volatility.

Inflation and The Fed

We know inflation has been rising steadily. It is now remarkably high, pervasive and ubiquitous. However, there are clear signs in recent weeks that inflation may have peaked in June.

Headline and core CPI inflation (Consumer Price Index) for July came in below the June highs and also below consensus expectations. The downside surprise to July inflation has now raised hopes that inflation may have started its descent from June’s lofty 9.1% perch.

It is still feared that wage inflation, which tends to be more sticky and stubborn, will be a key impediment to a swift reversal in inflation. For example, average hourly earnings grew by 5.2% in July on a year-over-year basis.

But a closer look at monthly changes in average hourly earnings others some hints of deceleration. In the last 6 months, average hourly earnings have increased at a slower pace of just around 4%. In contrast, wage gains in the prior twelve months were in the range of 5-6%.

A potential diminution in wage pressures is corroborated with a decline of over a million job openings in recent months and an increase in corporate layoffs.

As inflation and stagflation fears have given way to recession concerns in recent weeks, we have seen other compelling signs of disinflation and demand destruction.

  • Longer-term inflation expectations have come down dramatically. As an example, 5-year inflation expectations have fallen from a high of about 3.7% to around 2.6%.
  • Gasoline futures are off their highs by over 20%. And the average price of gas at the pump has declined steadily by over $1/gallon since mid-June.
  • The price of most commodities including copper, nickel, lumber, wheat and corn has also declined by more than 20% in recent weeks.
  • Supply chain pressures continue to decline even as demand seems to be getting weaker.

And finally, at the risk of re-igniting a controversial debate, our last argument in favor of subsiding future inflation comes from monetary theory instead of empirical evidence.

We have previously observed that the relationship between money supply growth and inflation seemed to have broken down after the 1980s. This was borne out by the data between 1990 and 2020.

We believe that this relationship was meaningfully restored over the last couple of years. The recent surge in money supply had a bigger impact on inflation than in prior years because of its sheer size and origin. The colossal $10 trillion of monetary and fiscal stimulus was unprecedented in magnitude. And stimulus checks literally took the form of inflationary “helicopter” money.

As a result, we have seen a revival of Milton Friedman’s well-known thesis that inflation is always and everywhere a monetary phenomenon. As goes money supply, so goes inflation. We believe this played out in a material way in 2021 and 2022. We also acknowledge that the pandemic effects of supply chain disruptions and pent-up demand further exacerbated inflationary pressures.

We show year-over-year changes in money supply and inflation in Figure 1.

Figure 1: Money Supply Growth and Inflation

Source: St. Louis Federal Reserve

Our measure of money supply is M2 which typically includes checking, savings and money market accounts. It is shown above in blue. The green line shows the year-over-year change in CPI inflation.

We see two effects playing out in this relationship. One, fiscal stimulus tends to have a bigger impact on inflation than monetary stimulus. And two, monetary stimulus generally works on a lagged basis ... typically after 6 to 12 months.

Money supply shot up and peaked at over 25% in early 2021. We believe it contributed to the spike in inflation a year later.

But from that peak, money supply growth has declined dramatically in the last year or so. There are no more stimulus checks and the Fed is now tightening.

We believe that the recent decline in money supply growth has not yet fully impacted inflation. On the same lagged basis, it will likely reduce inflation in the coming months.

We close with a final word of caution on the outlook for inflation. We do not expect inflation to abate nearly as quickly as the rate at which it shot up.

The ongoing war in Ukraine will continue to dislocate commodity prices and supply chains. And even as energy and goods inflation tails off, services inflation which includes rents and wages will likely be stickier and more persistent.

As a result, while inflation will likely recede, it will do so slowly and remain above target in 2022 and 2023. We expect core PCE inflation (Personal Consumption Expenditures) at around 4% by the end of 2022 and at about 3% by the end of 2023.

So, where does all this leave the Fed? And what do they need to do next?

The misguided belief on the Fed’s part last year that inflation would be transient leaves it in a difficult spot in 2022 – fight inflation and risk a recession or avoid a recession and risk a long inflationary spiral.

Its dilemma is further compounded at this point. The Fed finds itself at peak hawkishness with consecutive 75 basis point hikes even as inflation may be peaking.

We begin our discussion on the Fed with a quick recap of their policy responses so far. Yes, the Fed was hopelessly late in beginning its tightening cycle. But we believe they are not as far behind as the current gap between a Fed funds rate of 2.25% and July’s headline CPI print of 8.5% may suggest.

While the Fed was late to raise rates, they did use their policy tool of forward guidance to good effect in engineering a slowdown.

The Fed has clearly communicated in recent months what they expect to do in the future. As a result, financial conditions have already tightened in the form of higher interest rates, a stronger dollar and lower stock prices.

We also anticipate a lower cap to the Fed funds rate than many may fear. We believe that today’s high inflation is not simply a demand problem, it is also a supply issue. In so far as this may be true, the Fed will get some help in the fight against inflation ... and it will come from the private sector as supply chains continue to get restored.

So, should the Fed continue on its policy path or consider a pause or a pivot if inflation does peak?

The 2y-10y portion of the yield curve is already steeply inverted. At its current projected pace, the Fed will invert the short end of the yield curve as well by November.

Does the Fed have any options but to invert the entire yield curve before the end of the year?


The Fed’s hawkish stance has so far succeeded in preventing current inflation from becoming anchored in inflation expectations. To keep inflation expectations muted and avoid an inflationary spiral, the Fed needs to continue hiking in the foreseeable future.

But at some point in the next several months, the Fed may have some flexibility. By then, it may be able to look back at a clearly visible peak in inflation. If June proves to be that peak, the Fed may then have enough evidence of falling inflation to consider a shift in policy.

We believe a pivot to rate cuts anytime soon would be a mistake; it runs the risk of prolonging the inflationary cycle much like it did in the 1970s. We believe, however, that a “no-promises” pause in 4 to 6 months may not be as unlikely as many believe... especially if the incoming data shows a clear and convincing trend of disinflation.

We focus next on the depth and duration of a potential recession and the current bear market.

Recession and Bear Market

Investors have agonized about a long list of concerns for several months now. There is one common theme across all these sources of anxiety. Just how severe will this current bear market or a potential recession be?

We look at several factors to answer this question and conclude that the worst fears on this front may be unfounded.

We first assess the impact of higher interest rates on the broad economy. And we do so through two potential transmission mechanisms – its impact on the housing market and corporate profits.

We have addressed concerns about the housing market in our prior writings. It is true that higher mortgage rates have combined with high home prices to push mortgage costs to their highest level since 2008.

But we still refute concerns of a dire housing situation or parallels to the 2008 Financial Crisis for a number of fundamental reasons. These include a limited supply and inventory of homes, greater credit-worthiness of borrowers and a significantly lower household debt to income ratio.

We also uncover an interesting and less-understood observation related to interest expenses and corporate profits.

Corporate debt is typically laddered across a wide range of maturities. On this spectrum, variable rate and short-term debt resets almost immediately to higher interest rates; longer-term debt does not. As a result, short-lived exogenous shocks in corporate bond yields simply don’t transmit as quickly or materially to interest expenses.

We saw this phenomenon during the Global Financial Crisis and we are likely to see it this time around as well. With the abundance of easy money until last year, corporations were quick to refinance most of their debt to much longer maturities.

Less than 15% of corporate debt today is in short-term and variable rate debt. More than 30% of corporate debt has a maturity of 10 years or longer. Based on this distribution, overall interest expenses are unlikely to rise sharply any time soon.

We offer one final observation in support of our belief that any potential recession is less likely to be deep and protracted.

The strength of the U.S. economy at the beginning of the year was based on a strong U.S. consumer. The strength of the consumer in large part is derived from the health of the labor market.

Figure 2 shows that the labor market has held up surprisingly well through the turmoil this year. Cumulative job growth has handily outstripped GDP growth in 2022.

Figure 2: Employment and GDP

Untitled design (77)

Source: St. Louis Federal Reserve

Figure 2 shows two consecutive quarters of negative real GDP growth which suggests that we may be in a recession right now. However, it is hard to square that up with the health of the labor market. We see in Figure 2 that employment has been strong – more than 3 million new jobs have been created in 2022 through July and the unemployment rate is at 3.5%. In the same period, Gross Domestic Income (GDI) has also been positive and divergent from GDP.

The National Bureau of Economic Research (NBER) determines the beginning and end of recessions using several metrics. GDI and employment are two of the more important factors in their assessment. It will be curious to see if the NBER eventually labels the first half of 2022 as an official recession or not. We wouldn’t be surprised if the answer turns out be No.

We believe that the economy is strong enough where any potential recession, should it unfold, will be short and shallow.

And how about the current bear market in stocks? Could it become more severe and protracted? Is the recent uptick in stock prices the beginning of a new bull market or simply a bear market rally?

The outlook for stocks depends on how resilient corporate earnings turn out to be in the coming months. Earnings have held up remarkably well through the first half of 2022. In the first two quarters, earnings came in well above consensus expectations. 2022 earnings growth for the S&P 500 is still on track to match its 9% estimate from the beginning of the year.

While earnings estimates for 2023 have declined a bit in recent weeks, they also remain surprisingly robust. Earnings for the S&P 500 in 2023 were projected to be around 250 at their high point; they are now estimated to be 2% lower at 245.

It was widely expected that high inflation and a strong dollar in the second quarter would take a bigger toll on corporate profits. Those fears have not yet been realized. In fact, if inflation peaks in June, inflation and currency headwinds will only diminish from this point on.

In order for stocks to retrace their recent gains and create new lows, we estimate that 2023 earnings need to fall by another 10-15% to the 210-220 level. We deem this to be less likely than feared. If the devasting second quarter could dent 2023 earnings by only 2%, then subsequent quarters with weaker head-winds are unlikely to inflict greater damage.

We believe that the underlying strength of the U.S. economy and company fundamentals will allow earnings to withstand adverse inflation and currency effects.

There is still a dominant view in the investment community that the recent rebound in stock prices is simply a bear market rally that will eventually give way to new lows. We assign a greater probability to the counter view that this may be the start of a new bull market.

In summary, we do not expect the current growth scare to degenerate into a prolonged recession or a lengthy bear market.

We also look further out into the next decade and offer the following perspectives on the economy and the markets.

Longer Term Outlook

Here is a brief look at the longer term outlook for inflation, interest rates, and stock and bond returns.

The last five decades have seen 3 distinct inflation regimes. We show them in Figure 3.

Figure 3: CPI Inflation in the Last Five Decades

Source: St. Louis Federal Reserve, 2022 – year-over-year change as of July

Figure 3 shows that inflation was about 8% on average during the 1970s. It then declined to around 3% from the 1980s to the Global Financial Crisis (GFC) and fell even lower to around 2% after the GFC. Which of these 3 regimes are we likely to see over the next decade?

We have already argued against a prolonged 1970s type of recessionary spiral. We also believe that the 2% post-GFC inflation represents a cyclical low which may be difficult to reach in the next cycle.

The GFC was a severe financial crisis which then led to an even more pronounced deleveraging cycle in its aftermath. Absent such a strong disinflationary force and in the face of potential de-globalization, we believe inflation in the coming decade is more likely to be around 3% than around 2%.

In this setting, we expect the neutral long-term Fed funds rate to remain around 2.5-3.0%. At these levels, it will keep pace with realized inflation.

The post-GFC and post-Covid periods were characterized by low, and even negative, long term interest rates across the globe. Real interest rates, net of inflation, were significantly more negative.

We believe that this era of easy money is now over and expect interest rates to be higher in the next decade. U.S. Treasury bond yields will likely be in the 3-4% range and, as a result, real long term rates will also be positive.

We believe real GDP will settle in at a more normal level of around 1.5-2% in the next decade. This should still allow earnings to grow in the range of 6-8%.

We next assess what a fair Price/Earnings (P/E) multiple might be for stocks going forward.

We draw on historical precedent in Figure 4 to answer the question.

Figure 4: P/E Multiples by Inflation Regime.

Screen Shot 2022-08-25 at 6.50.30 PM

Source: Strategas

Figure 4 shows trailing 12-month P/Es across different inflation regimes. Stocks perform best when inflation is low and between 0 and 4%. At either extreme, both deflation and high inflation tend to destroy profit margins and compress P/E multiples.

Based on the data shown in Figure 4, our expectations of inflation around 3% and our view on interest rates, we believe that the fair P/E multiple for the S&P 500 index in the next cycle is likely to be 18-19 times trailing 12-month earnings.

We expect this economic backdrop will lead to more traditional returns for stocks, bonds and cash. It is likely that cash generates returns in the 2-3% range, bond returns are around 3-5% depending on credit exposure and stock returns are between 7-9%.

Within these ranges, investors can expect normal levels of risk premiums for bearing the risk of investing in stocks and bond over the next decade.


The sheer breadth and depth of economic uncertainty so far in 2022 has been truly unprecedented. We have rarely, if ever, seen such divergent economic and market forecasts in the past.

In an effort to filter some signals from all the noise, we summarize our key observations at this crucial juncture.

We believe:

  • Inflation will moderate from here and recede gradually
  • Short and long Treasury rates are less likely to exceed 4%
  • Any potential recession, should it unfold, is less likely to be deep and protracted
  • The bear market in stocks may well be shorter than most investors expect
  • Stocks offer more upside than downside over the intermediate term

We are mindful of the broad range of unknowns at this point and the even greater need to invest with care and prudence. We remain firmly committed to the basic principles of portfolio diversification, risk management and investing in high quality companies.

We do not expect to see a lengthy recession, should it even unfold, nor a prolonged bear market. 


We also expect to see a more normalized regime of inflation, interest rates and valuations in the next decade.

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By Whittier Trust

It’s nearly impossible to turn on the television or read an economic journal without being confronted with news about stock market volatility, inflation and the possibility of rising interest rates. Ultimately, market factors are always in play. Economies, and the components that make them up, are always fluid.  

“While interest rate hikes during the first six months of 2022 have affected our ability to buy properties, the fundamentals of the properties haven't changed much,” says Whittier Trust Senior Vice President of Real Estate Juliana Ricks, who advocates a long-term approach to real estate investing. “We're still finding quality properties that we like and ones we feel could ride out any cycle in terms of valuation.” Here are some of the reasons why a long-term approach is a winning strategy for real estate investing. 

A Good Buy

As with any potential investment, vetting every element of not only the property itself but also the environment around it can help predict whether the investment will pay off in the long run. 

When Whittier Trust’s real estate division evaluates a new piece of multi-family real estate in which to invest, they are looking for population growth and job growth over time. While any location is open for consideration, Whittier tends to be most focused on major cities that have a long-term track record, as opposed to small towns with sudden surges. “We want to be invested in places that we think will do well over a long period. It’s less speculative,” Ricks says, which can translate into more secure investments for Whittier Trust’s clients. 

Although the team looks at all property types, most of Whittier Trust’s recent investments have been in multifamily properties. Since the three to five real estate investments each year involve between $15M and $20M in client equity, their team investigates whether rents are increasing in the market and occupancy rates and demand for housing are high. Whittier Trust’s investment group becomes the sole limited partner, holding 95% of a project’s equity, while an operating partner familiar with the market and property type typically holds a 5-10% investment and the responsibility of the day-to-day management. Key elements are investigated and evaluated to determine whether or not a project has the potential to be a smart long-term investment. 

Patience for the Long-Haul

When Whittier Trust embarks on a new real estate investment, they generally look at investments on a 10 to 12 year horizon, although they would sell sooner if a great opportunity comes along. It’s a vastly different approach than the goal of making a quick return or planning to “flip” a property. “Within that range, there will likely be an opportunity to have a good outcome for the asset. That sort of staying power in real estate is important because it allows us to ride out the economic cycles,” Ricks explains. 

With housing costs—both for single-family homes and rents—on the rise across the United States and interest rates climbing, it’s vital to look toward markets that have a proven track record. “While everything's fair game, there are certain markets that have fared better [during economic downturns]. We certainly think about which markets would be okay if there were a down cycle,” Ricks says. Even with some market volatility, planning to hold onto a piece of real estate for a decade or more gives the investment time to produce solid returns for Whittier’s clients. 

Interest Rates’ Impact on Real Estate Investing 

As any real estate investor knows, a property is worth what someone is willing to pay for it. However, during a period of ultra-low interest rates, buyers could afford to pay more for properties in some cases. That’s changing as interest rates rise, and it requires a nuanced approach to get the best result for Whittier Trust clients. 

“We're at a certain place in terms of valuation based on cap rates,” Ricks explains, adding that interest rates have increased by two full percentage points since the beginning of 2022. “Valuations haven’t necessarily gone down as quickly. Interest rates are significantly higher than the cap rates on many properties, which means that the unlevered yield would be lower than the interest you're paying. You're back in this position where you're having to fund debt service initially, as the property stabilizes.” 

Whittier Trust’s Real Estate division looks for investments that are both solid buys and growth opportunities, with the objective to generate lucrative returns, even in the face of interest rate fluctuations.  And, should interest rates drop over the life of a property, refinancing for a more advantageous position is possible. 

Building a Legacy 

This long-term approach perfectly aligns with one of Whittier Trust’s core focuses: legacy-building by passing wealth intergenerationally. “We know that there is staying power in real estate. If you can hold on to assets, historically they tend to recover their value” Ricks says.  

Approaching real estate investments conservatively so that they will perform well over time includes going back to basics to make sure the fundamentals are solid, choosing a good location, partnering with top-notch management and not putting too much debt on the property. By the time Whittier Trust closes any deal, “we've researched the market to understand the conditions that will make the property perform well,” Ricks says.

The market turbulence of 2022 stands in sharp contrast to the utopian mix of easy money, low volatility and high returns seen in 2021. It is now widely acknowledged that inflation is perhaps the most disruptive theme contributing to economic uncertainty. High inflation can act as a tax and slow growth by itself. It also increases the risk of a policy misstep where overly aggressive tightening by the Fed may trigger a recession.

In this webinar, Sandip Bhagat, Chief Investment Officer at Whittier Trust, and David Shaw, Publishing Director at Family Business Magazine, come together for a discussion on inflation and its impact on your family business.

Contact us to learn more about how our team of advisors can help you.

Whittier Trust Company and The Whittier Trust Company of Nevada, Inc. are state-chartered trust companies, which are wholly owned by Whittier Holdings, Inc., a closely held holding company. All of said companies are referred to herein, individually and collectively, as “Whittier”. The accompanying materials are provided for informational purposes only and are not intended, and should not be construed, as investment, tax or legal advice. Please consult your own investment, legal and/or tax advisors in connection with financial decisions and before engaging in any financial transactions. These materials do not purport to be a complete statement of approaches, which may vary due to individual factors and circumstances. Although the information provided is carefully reviewed, Whittier makes no representations or warranties regarding the information provided and cannot be held responsible for any direct or incidental loss or damage resulting from applying any of the information provided. Past performance is no guarantee of future results and no investment or financial planning strategy can guarantee profit or protection against losses. These materials may not be reproduced or distributed without Whittier’s prior written consent.

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Inflation has been a trending topic in the news as supply chains and labor shortages continue to struggle to meet market demands. Though this current climate may reduce an investor’s confidence, there is an upside: larger gift tax exemptions. The increase in gift tax exemptions has increased to $16,000 per donee, which means that tax savvy individuals can reduce the overall tax burden of their estate.

The current lifetime gift tax exemption allows for individuals to give over $12million per donee. While this is set to “sunset” in 2025, there has never been a better time to take advantage of this opportunity. Though taking advantage of this exemption is extremely lucrative, it should not be done without the oversight and guidance of a qualified estate planner, as errors can be incredibly costly. Talk to your advisor to craft an effective strategy about how you can protect your estate for future generations.

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Above-trend Growth in 2022 


The remarkably short Covid recession of 2020 was followed by a rapid and powerful recovery in 2021. Bolstered by massive policy stimulus, global economies and markets were resilient enough to overcome uncertainty from virus variants and inflation spikes.

The U.S. economy grew by almost 6% in 2021 in real terms even as CPI inflation reached 7% by the end of the year. The S&P 500 index led global equity markets with a stunning total return of 28.7%. In an even more astonishing outcome, stock market volatility remained unusually low. The maximum drawdown from peak to trough in the S&P 500 index was only -5% in 2021.

The strength in the economy and the markets was based on solid fundamentals. Heading into 2022, the Purchasing Managers Index, which serves as a useful leading indicator of economic activity, still remains firmly at expansionary levels.

However, an increasingly hawkish stance from the Fed roiled the stock and bond markets early in the New Year. It wasn’t too long ago that the Fed had appeared overly sanguine about inflation. As recently as September, the Fed was projecting zero rate hikes in 2022. It has since changed its position in a number of ways.

The Fed has stepped up its pace of tapering which is now expected to end in March. It is also projecting 3 rate hikes in 2022 with more to follow in the next two years. These actions were initially met with enthusiasm in the markets as they dispelled fears that the Fed was falling behind the curve in fighting inflation.

However, what came as a shock to the markets on January 5, 2022 was the Fed’s consideration of a reduction in its balance sheet soon after the first rate hike. This trifecta of tapering, rate hikes and now quantitative tightening (QT) was deemed to be an insurmountable “triple threat” for both stocks and bonds.

>We have highlighted for a while now that we have reached an inflection point in policy stimulus and that growth will slow down from its 2021 peak. Our outlook for 2022 focuses on one key question.

Will the decline in growth be exacerbated by a policy mistake around inflation or will growth still come in above trend to sustain the economic cycle and bull market? We assess risks to the economy from the virus, inflation and the Fed. We balance these risks out against the continued tailwinds for growth from prior stimulus, easy financial conditions and a healthy U.S. consumer. Along the way, we also look more closely at earnings growth in light of historically elevated stock valuations.

Omicron, Inflation, and The Fed


We believe that Omicron will have limited economic impact despite its high rate of transmission. The current vaccines have been reasonably effective at preventing severe disease. They have also been successfully rolled out; the older, more vulnerable age groups have vaccination rates in excess of 90%.

The Omicron variant of the virus has also mutated significantly. While this makes it more transmissible, it may also make it less potent. The current data shows that a smaller percentage of all infected people have been hospitalized than before. And an even smaller percentage of hospitalized patients have been admitted to the ICU.


We do not expect inflation to spiral out of control like it did in the 1970s. That bout of inflation was triggered by a supply side shock in the oil market. We do not see a similar parallel in 2022. We agree with the Fed and the consensus forecast that inflation will peak in the first half of 2022.

Our reason for this view is simple. Prices became so elevated in 2021 from the immediate shock of the pandemic that future price increases are likely to be more muted as the intensity of that shock abates.

Our third observation on inflation is a departure from the consensus view. We expect that inflation will subside at a slower pace than most expectations.

We, therefore, expect inflation to remain higher than consensus or Fed forecasts in 2022 and 2023. Having said this, we do not expect inflation to adversely impact the economy or the markets. When inflation and interest rates go up from extremely low levels towards 3 to 4 percent, stocks generally do well in a robust economic recovery.

The Fed

We do not believe the Fed will commit a major policy mistake any time soon. The hallmark of its policy for over a decade has been an overly accommodative stance.

The Fed has constantly erred on the side of risking inflation from being dovish than on risking another recession from being hawkish. Its recent decision to allow inflation to run well above 2% before raising rates is another example of its desire to go slow instead of going fast.

The Fed can always be data-dependent and we expect it to alter course as necessary.

We move to the more promising drivers of growth in the next couple of sections.

Legacy Tailwind of Prior Stimulus

Investors have worried about the inflection of both monetary and fiscal stimulus for quite a while now. More central banks have raised rates globally than cut them. Fiscal stimulus going forward will be a tiny fraction of what was seen in 2020 and 2021.

We believe, however, that investors are underestimating the powerful legacy of prior stimulus as a tailwind for future growth. We discuss a few examples of how financial conditions are still accommodative on the heels of the Covid policy responses.

We begin with a look at just how massive global monetary stimulus was during the Covid crisis.

Figure 1 shows quantitative easing (QE) from the four major central banks of the world over the last 15 years.

Figure 1: G4 Central Bank Balance Sheets, $ Trillion and % of GDP

A chart showing the G4-Central Bank Balance Sheet.
Source: KKR Global Macro and Asset Allocation, as of 10/31/21

The G4 central banks expanded their balance sheets by more than $9 trillion in the Covid crisis. This injection of liquidity was a staggering 21% of GDP. It was also 3 times bigger than their policy response after the Global Financial Crisis (GFC).

The Fed alone grew its balance sheet by more than $4.5 trillion and is now ready to start reducing it. At what pace might that happen? We turn to the last tightening cycle for a precedent. In 2017, it took the Fed almost 2 years to reduce its balance sheet by about $700 billion. We believe that any quantitative tightening in 2022 will only be a small fraction of the existing stock of liquidity that the Fed created previously through QE.

We believe that the Fed’s balance sheet will still remain sizeable and provide sufficient support and stimulus to aid above-trend growth in 2022.

Global monetary stimulus during Covid also resulted in extremely low interest rates.

We show global real interest rates in Figure 2. Real rates are defined as nominal rates minus long-term inflation expectations.

Figure 2: Real 10-Year Government Bond Yields

A chart showing the Real 10-Year Government Bond Yields.
Source: Bloomberg, as of 11/30/21

As we can see in Figure 2, real rates are negative in most countries. They are also well below their trailing 10-year averages.

We fully expect real rates to rise as growth remains strong, the Fed starts to tighten and inflation begins to subside. But because real rates will rise from such historically low levels, we expect financial conditions to still remain easy and accommodative.

We can also see legacy tailwinds from fiscal stimulus. Savings rates shot up on the heels of the initial rounds of fiscal stimulus as consumers were unable to spend all of their stimulus checks. These excess savings were banked and have since grown into a sizeable pool of reserves for consumers.

By most calculations, cumulative excess savings are estimated to be over $2 trillion. At around 17% of Personal Consumption Expenditures and almost 10% of GDP, this cash on the sidelines bodes well for future consumer spending.

And the consumer is strong in many other ways. Household net worth has grown exponentially from the rapid Covid recovery, a booming stock market and a red-hot housing market. Debt payments as a percent of household income are at an all-time low. The jobs market has almost fully recovered now with the unemployment rate below 4%.

Strong economic fundamentals have sparked reflation and high nominal GDP growth. We expect nominal GDP growth to be around 8% in 2022. At these levels, economic growth will far exceed nominal GDP growth seen in the last 20 years.

The above-trend growth in nominal GDP also bodes well for corporate profits. We look at the outlook for earnings growth and its impact on stock prices in the next section.

Earnings Growth and Stock Returns

We first highlight an important inflection point in stock market leadership.

The initial phase of a new bull market is typically driven by abundant liquidity. Stock prices move higher in anticipation of an eventual recovery. However, this early move in prices can happen even as actual earnings decline or throughout. As a result, P/E multiples expand dramatically in this liquidity induced phase of the bull market. We saw this play out in 2020.

We transitioned to the next phase of the equity bull market in 2021. In this growth-driven phase, earnings growth becomes the main driver of stock prices and P/E multiples begin to decline.

Figure 3 shows this effect with visual intuition.

Figure 3: S&P 500 Return Contributions in 2021

A chart showing the S&P 500 Return Contributions in 2021.
Source: FactSet, as of 12/31/21

Earnings growth reflects change in forward earnings estimates

The green line in the chart shows the S&P 500 price return of 26.9% in 2021. The light blue line at the top shows earnings growth of 34.6%.

The only way to reconcile a lower return than the growth in earnings is through a decline in the P/E multiple. This multiple compression of -7.7% is shown in the dark blue line at the bottom of Figure 3.

We expect this pattern to repeat itself in 2022. The magnitude of the numbers, of course, will be different but we believe the pattern will be similar. We expect earnings growth will be strong enough to more than offset a continued decline in the P/E multiple.

Our optimism for earnings growth stems from a couple of fundamental factors e.g. revenue growth and margin growth.

Revenue growth tends to be highly correlated with nominal GDP growth and is also expected to be around 8% in 2022. At these levels, it will be significantly higher than revenue growth seen in the last two decades. We expect revenue growth to remain above trend in the foreseeable future.

We are even more intrigued by the continued contributions to earnings growth from high profitability. Profit margins for the S&P 500 index continue to rise. Net margins reached an important milestone in 2021 as they crossed the 12% threshold for the first time ever.

In fact, profit margins have grown steadily for the last 20 years from the mid-single digits to the low-double digits. Contrary to conventional wisdom, the trend suggests a structural shift upwards in profitability.

We take a closer look at profitability.

Figure 4 shows trends in profitability over time and across sectors.

Figure 4: Change in Profit Margins over Time by Sector

A chart showing the Change in Profit Margins over Time by Sector.
Source: FactSet, Whittier, as of 12/31/21

We show current profit margins in green and profit margins from 2011 in blue.

The breakdown of profitability by sector reveals several insights.

  • Profitability varies significantly across sectors. The most profitable sector is Technology and the least profitable sector is Consumer Staples.
  • Growth in profit margins over time also varies significantly by sectors.
    •  The most profitable sector, Technology, has also seen a big increase in profitability.
    • So has the Communications sector.
    • The Energy sector is the only sector to see a decline in profit margins.
  • These results are intuitive. Communications has become a more profitable sector after Google and Facebook were added to the sector. Technology includes high margin companies like Apple and Microsoft.
    • Growth in profit margins also helps explain sector and market valuations.
    • The Technology and Communications sectors are more valuable with a bigger market cap because they are more profitable.

Figure 5 highlights the base effects of margin growth over time and the mix effect of margin growth across sectors.

Figure 5: Mix Shift for High Margin Growth Sectors

A chart showing the Mix Shift for High Margin Growth Sectors.
Source: FactSet, Whittier, as of 12/31/21

Figure 5 shows base and mix effects for two sectors with high margin growth. The purple bars show Communications and the grey bars show Technology.

The first pair of bars shows how profit margins have increased for these two sectors in the last 10 years – by 12% for Communications and 9% for Technology. The next pair of bars shows that at the same time, their weight in the index has also increased – by 5% for Communications and 12% for Technology.

On the other hand, sectors with low margin growth, such as Energy and Consumer Staples, show the opposite outcome – no growth in profit margins and a decline in their index weight.

These observations help us understand the recent rise in profit margins.

We believe strong revenue and margin growth will drive above-trend earnings growth and create potential for upside surprises.

We use these insights to inform our economic and market outlook.

Outlook For 2022

We expect the post-Covid economic cycle and bull market to continue in 2022 but with several important distinctions.

This cycle is more likely to resemble the post-Internet Bubble recovery than the post-GFC one. A key characteristic of this cycle will likely be steady reflation instead of the sustained disinflation we saw in the previous cycle. And finally, we expect stock returns in 2022 will likely be lower and more volatile than they were in 2021.

We summarize the key tenets of our 2022 outlook below. We believe:


  • Virus variants will continue to have limited economic impact
  • Inflation will remain above consensus expectations in 2022 and 2023 but will not meaningfully impede growth or profit margins
  • Fed will avoid a major misstep in 2022
  • Above-trend nominal GDP growth in 2022 may exceed current expectations

Earnings, Revenues, Profits and Valuations

  • Earnings growth will remain significantly above trend in 2022
  • Revenue growth and profit margins will remain well above trend
  • P/E multiples will compress modestly as interest rates rise gradually
  • However, stock valuations will not revert to their long-term mean in the near future

Asset Classes

  • Stocks will handily outperform bonds and cash in 2022
    • Above-trend earnings growth will offset modest P/E compression
    • Equity returns will be in the mid to high single digits with upside potential
  • Select Real Estate is especially attractive at this stage of the cycle
    • Cash yields could exceed bond yields
    • Correlation with nominal GDP creates useful inflation hedge
  • Private market investments should outperform their public market counterparts

Sectors and Themes

  • Value and cyclical stocks will perform well in 2022 e.g. Energy, Financials, Industrials
  • Credit will outperform duration
    •  Credit spreads will remain lower for longer
    • Nominal rates will rise by 50 to 75 basis points
  • The following themes will attract investor interest
    • Pricing power
    • Real assets
    • Energy transition and ESG investing
    • Innovation and disruption

We recognize that inflation is now the main investment risk in 2022. We are mindful that the seismic dislocation of global supply chains may create some unexpected outcomes and pose risks to our views on inflation and the Fed.

Nonetheless, we remain optimistic on the economy and the market. We expect growth to remain above trend and stocks to perform well. At the same time, we exercise restraint and discipline in managing portfolio risk.

Inflation has now emerged as the biggest investment risk in 2022. Will inflation or a related Fed policy mistake exacerbate the deceleration of growth from its 2021 peak?


We believe growth will still come in above trend to sustain the economic cycle and bull market.

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