December 2021
US Economy: Unsettling inflation.
Accelerated inflation continued to dominate economic headlines, with the Consumer Price Index for November rising 6.2% year-over year, the fastest pace since 1990. US wages were also up (+4.2%) but not as much as prices, contributing to lower consumer confidence (109.5 in Nov vs. 111.6 in Oct).
US Stocks: Omicron erases gains.
Until Thanksgiving, US equities were up for the month, but the new Omicron variant of Covid-19 has since rattled investors. Small-cap stocks were especially hard-hit due to perceived greater sensitivity to Covid-19 restrictions and mitigation, even as more money flowed into small caps attracted by lower valuations.
Foreign Stocks: Currency headwinds.
A stronger US dollar, driven by its safe-haven status and the prospect of higher US interest rates, dented equity returns in foreign markets by 1% to 2%. Turkish equities lost more than 12% as the central bank there lowered interest rates despite rampant inflation, a great example of a central bank policy error.
Fixed Income: Round trip on yields.
The yield on 10-year US Treasuries hit 1.7% but then retreated on Omicron concerns. Interest rates had been rising in anticipation of the Fed starting to fight inflation by curtailing stimulus measures sooner and more broadly — greatly reducing Fed monthly bond purchases and raising the Fed funds rate.
Real Assets: Commodity pullback.
Most types of commodities lost ground on slowing demand and a weaker outlook due to the spread of the Omicron variant. Energy was especially hard-hit (-17%) after strong gains in 2021. Even precious metals (-1%), long considered a safe haven, could not buoy real assets returns.
Alternatives: Hedging shortfall.
Hedge funds can be valuable portfolio diversifiers over the long term, but they don’t always perform as expected in the short term, including during market selloffs. Many hedge funds struggled in November as prevalent trends reversed, with lower stock prices, falling interest rates, and a stronger dollar.
Equities Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (0.7%) | 23.2% | 27.9% |
| U.S. Small Cap | (4.2%) | 12.3% | 22.0% |
| U.S. Growth | 0.3% | 23.4% | 29.4% |
| U.S. Value | (3.5%) | 18.1% | 22.9% |
| Int’l Developed | (4.7%) | 5.8% | 10.8% |
| Emerging Markets | (4.1%) | (4.3%) | 2.7% |
Fixed Income Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 0.3% | (1.3%) | (1.2%) |
| TIPS | 0.9% | 5.6% | 6.8% |
| U.S. High Yield | (1.0%) | 3.4% | 5.4% |
| Int’l Developed | (0.4%) | (8.9%) | (7.1%) |
| Emerging Markets | 0.1% | (1.5%) | 0.6% |
| Tax-Exempt | |||
| Intermediate Munis | 0.3% | 0.4% | 0.7% |
| Munis Broad Mkt | 0.8% | 1.7% | 2.4% |
Non-Traditional Assets Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (7.3%) | 22.8% | 28.9% |
| REITs | (1.0%) | 28.9% | 32.1% |
| Infrastructure | (5.3%) | 4.9% | 8.1% |
| Hedge Funds | |||
| Absolute Return | (0.7%) | 1.3% | 2.6% |
| Overall HF Market | (0.9%) | 3.6% | 6.1% |
| Managed Futures | (2.6%) | 7.0% | 6.9% |
Economic Indicators
| NOV-21 | MAY-21 | NOV-20 | |
|---|---|---|---|
| Equity Volatility | 27.2 | 16.8 | 20.6 |
| Implied Inflation | 2.5% | 2.5% | 1.8% |
| Gold Spot $/OZ | $1775 | $1907 | $1777 |
| Oil ($/BBL) | $71 | $69 | $48 |
| U.S. Dollar Index | 116.9 | 111.0 | 113.5 |
Our Take
It’s beginning to feel like “Groundhog Day” yet again, and the winter hasn’t even officially started. Covid-19 and its many variants are still a key economic risk. Fortunately, new Covid hospitalizations remain well below the late-summer peaks even if they have ticked up in November. Despite much progress having been made against Covid, the Omicron variant has stirred renewed fears over the efficacy of existing vaccines and treatments, as Delta did.
US GDP growth slowed to 2.1% annualized in 3rd quarter 2021 due to the Covid-19 resurgence coupled with the expiration of extended unemployment benefits and fractured supply chains and labor markets. Consequently, we have seen investors follow a similar playbook to last year, pushing out economic growth expectations and becoming circumspect regarding cyclical reopening. What may be different this time: accelerated inflation has surpassed analyst expectations and Fed policy going forward seems likely to be less accommodative.
As we pointed out during our October investment webinar, the most serious risk to markets and the economy now is the Fed’s reaction to inflation. If prices are rising due to strong demand (demand-pull inflation), the Fed has good cause to raise interest rates without major damage to the economy. But if inflation is caused by fractured supply chains and labor markets (cost-push inflation) and the Fed increases interest rates to dampen demand so supply can catch up, that is likely to be a policy error.
Even though interest rates have fallen recently (the 10-year US Treasury yield is again below 1.4% on Omicron worries), the Fed has telegraphed tighter monetary policy in 2022, including cutting back on asset purchases more quickly than expected to fight inflation. Aside from stifling demand when it could potentially be declining, the resulting rise in interest rates could cause a difficult environment for both fixed-income securities and equities.
What We’re Doing
At year-end, its especially fitting to evaluate the need to rebalance portfolios and make any strategic allocation changes. Top-of-mind this year is risk management, with equity markets having delivered strong returns since the lows of March 2020, and valuations in some areas (predominantly US large-cap equities) looking a bit stretched.
Consequently, we are assessing overall equity risk and allocation in portfolios, including the most attractive sub-markets within equities. International stocks, both developed and emerging, have more attractive valuations at this time and could offer better risk-adjusted returns in the coming years.
Outside of equities, core fixed income continues to be our “risk-off” allocation, a stabilizer in portfolios. However, low current yields and the specter of rising interest rates have us considering complements to fixed income, which will not provide as much stability in a short-term selloff, but may contribute more positively to portfolio yield and total return over the long term.
