By mid-year 2021, the global economy—especially in the US—was getting back on its feet, with re-openings and earnings strength. But that surge kindled a strong rise in inflation after several dormant decades. While the services component of CPI has remained quiet, bottlenecks in the supply chain of goods strongly increased the heat of inflation, which has now continued longer than many anticipated. Lower consumer sentiment and higher inflation expectations troubled the fourth quarter. This pushed the Fed to accelerate its timeline for ending quantitative easing and most likely commencing interest-rate increases.

In all economic scenarios, COVID-19 variants will play a central role in the speed and success of US and global growth for 2022. Inflation will remain elevated for the first part of the year but will likely cool off in the second half. If inflation falls more quickly than expected, central banks may not need to tighten very much. And economic headwinds could also be reduced if the world is able to tame the worst effects of the pandemic.

Equity investors may have concerns over high valuations. But stocks are a resilient asset class through many headwinds, including periods of rising inflation and Fed tightening. And there are more reasonable valuation opportunities beyond the top 10 US megacap companies that now account for a record 30% of the S&P 500. Whether seeking opportunities in value or growth stocks, quality is a key factor—not just in the US, but in global markets as well.

For bond investors, inflation and rising rates suggest that a blended credit portfolio offers a better income-to-risk profile today. Although yield and spreads are tight in developed-market corporate credit, relative opportunities still exist—notably in emerging-market debt and securitized assets. For US investors, municipal bonds weathered 2021 better than US Treasuries or investment-grade corporates. Munis tend to have less interest-rate sensitivity, and muni credit tends to do better when 10-year US Treasury yields rise.

But as with all parts of the capital markets, it’s important to be selective. In these volatile and uncertain markets, it’s important to be active as you position your portfolio to participate and defend.