January 2022
US Economy: Shopping power.
US GDP growth was revised upward to 2.3% for Q3 2021 on slightly better than estimated consumer spending, an enthusiasm which persisted through December. Despite concerns over accelerated inflation (+4.7% core PCE) and the proliferation of the Omicron strain of Covid-19, US shoppers spent nearly 11% more during the holiday season in 2021 vs. 2019.
US Stocks: Easing Omicron.
US equities were volatile, on a vacillating narrative around Omicron. In the end, flat Covid hospitalization rates, FDA approval of boosters for the young, new treatment options and the resiliency of the US consumer drove the S&P 500 Index to an all-time high. Consumer staple stocks (+10%) shone as investors sought relatively attractive valuations and lower volatility.
Foreign Stocks: Europe strong, EMs lag.
European stocks (+6.6%) also finished near an all-time high capping their 2nd best year in local currency terms since 2009. China (-3.2%) pulled down emerging market returns, which were otherwise in line with developed markets. Chinese equities struggled in 2021 given the deterioration in domestic credit and real estate markets as well as sweeping regulatory reforms.
Fixed Income: Yields rebound.
The yield on 10-year US Treasuries rose amid an improving Covid outlook and clarity around how quickly the Fed’s ultra-easy monetary policy would end with inflation running hot. Fed Chair Jerome Powell indicated the central bank’s bond buying will end by March 2022 after being cut by an extra $15 billion monthly, and the Fed funds rate could rise by late winter.
Real Assets: Real estate shines.
US real estate was one of the best-performing asset classes of 2021 with a strong close to the year. Investors have preferred real estate and REITs as a hedge against inflation and with an eye toward economic reopening. Infrastructure stocks also performed well in December, with the utilities subcomponent (+9.4%) benefiting for the same reasons as consumer staples.
Alternatives: Hedge funds hold on.
As to be expected, hedge funds weren’t exceptional performers in a year marked by strong equity returns. Still, despite the “reopening” tide limiting differentiation between stocks and many managers being caught wrong-footed on rising interest rate expectations, hedge funds in general outpaced core fixed income and helped diversify portfolios in 2021.
Equities Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 4.5% | 11.0% | 28.7% |
| U.S. Small Cap | 2.2% | 2.1% | 14.8% |
| U.S. Growth | 2.0% | 10.9% | 25.8% |
| U.S. Value | 6.1% | 7.5% | 25.3% |
| Int’l Developed | 5.1% | 2.7% | 11.3% |
| Emerging Markets | 1.9% | (1.3%) | (2.5%) |
Fixed Income Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (0.3%) | 0.0% | (1.5%) |
| TIPS | 0.3% | 2.4% | 6.0% |
| U.S. High Yield | 1.9% | 0.7% | 5.4% |
| Int’l Developed | (0.8%) | (1.9%) | (9.7%) |
| Emerging Markets | 0.7% | 0.4% | (0.8%) |
| Tax-Exempt | |||
| Intermediate Munis | 0.1% | 0.1% | 0.4% |
| Munis Broad Mkt | 0.1% | 0.8% | 1.8% |
Non-Traditional Assets Total Return
| DEC | 3 MOS | 1 YR | |
|---|---|---|---|
| Commodities | 3.5% | (1.6%) | 27.1% |
| REITs | 9.6% | 16.2% | 41.3% |
| Infrastructure | 6.6% | 4.6% | 11.9% |
| Hedge Funds | |||
| Absolute Return | 1.0% | 0.3% | 2.0% |
| Overall HF Market | 0.5% | 0.1% | 3.7% |
| Managed Futures | 1.1% | (0.2%) | 6.5% |
Economic Indicators
| DEC-21 | SEPT-21 | DEC-20 | |
|---|---|---|---|
| Equity Volatility | 17.2 | 23.1 | 22.8 |
| Implied Inflation | 2.6% | 2.4% | 2.0% |
| Gold Spot $/OZ | $1829 | $1757 | $1898 |
| Oil ($/BBL) | $77.8 | $78.5 | $51.8 |
| U.S. Dollar Index | 116.0 | 113.4 | 113.5 |
Our Take
Entering a new year always feels like a new beginning, despite the fact that many of the trials and tribulations we have been working through remain right alongside us. Covid is still headline news while supply chain woes and inflation continue to be hot button financial topics. Nevertheless, we are optimistic about a return to more normal conditions in 2022 given new Covid treatments, broader vaccination eligibility and the arguably less severe Omicron strain coupled with persistent consumer spending and stable GDP growth.
Looking forward, additional financial market catalysts include Fed policy and interest rates as well as fiscal policy and regulation, including regarding energy. While it is always difficult to prognosticate, we think we can identify the characteristics of the market regime that these catalysts suggest we are entering and let that inform portfolio construction and stress-testing in our ongoing effort to have in place diversified portfolios containing the right exposures to mitigate risks and capitalize on opportunities. As such, we see greater volatility and cyclically (if not structurally) driven inflation among the most significant challenges ahead. More on this in our Q1 2022 Quarterly Commentary later this month.
What We’re Doing
After an exceptionally positive or negative year it’s natural to rebalance portfolios to keep the desired risk-reward characteristics in place and we continue to make that recommendation. Within equities, while valuations abroad look slightly better, they are not so much better that we are willing to recommend overweighting those positions.
With regard to reducing risk, given the possibility of elevated volatility, a stake in fixed income and cash is appropriate now, but done in a way that does not dramatically reduce portfolio potential return.
Additionally, with equity valuations high and interest rates low, it is likely that investors will have better odds of achieving their return objectives by taking advantage of opportunities in the private markets (equity, debt and real assets) that offer a return premium in exchange for limited liquidity. Real assets in particular may also benefit portfolios if accelerated inflation becomes a longer-term issue.
Lastly, environmental and social sustainability is a secular trend we believe will offer investors opportunities to participate in growing market segments while potentially helping to reduce risk. As such, we are finding for our clients new sustainable investing solutions via the public and private markets.
