All Time Highs
US stocks kept on rolling higher through December, capping off another quarter of gains and culminating in what turned out to be an excellent run of performance in 2021. Over the course of the year, the S&P 500 delivered 29% total return, with growth mildly outperforming value, by 2%, and large-caps substantially outperforming small-caps, by 14%.
In fixed income, the US 10-Year Treasury yield finished the year at 1.5%, rising over half a percentage point over the proceeding twelve months, the largest one-year yield increase since 2013. In addition, credit spreads either remained tight or further compressed throughout 2021, aiding performance.
Our Perspective
The persistent economic recovery boosted equity performance both in the US and abroad as the global macroeconomy began to normalize and consumers went out and spent in a wave of pent-up demand.
Despite the economic strength this year, both the economy and financial markets are facing a variety of building risks as they turn the calendar. How the global economy responds to the Omicron variant, whether fading stimulus measures cause a reduction in growth, and how markets react to anticipated central bank rate hikes and rising inflation are all key questions on the horizon.
Given market valuations in both equities and fixed income, as well as our outlook for slowing economic growth ahead, we believe a balanced or neutral asset allocation remains appropriate as we head into the new year.
When Fundamentals Win
The Energy sector experienced turbulence throughout the course of the global pandemic with supply challenges, surging demand, and periodic government intervention.
Take November 2021, for example, when oil traded for its highest price in nearly seven years and sparked government intervention to boost supply. Oil markets would remain volatile, however, culminating in a late November selloff on demand fears from the rapidly spreading Omicron variant.
Our Perspective
Given Energy’s commodity characteristics we use our Hurdle Rate strategy to identify trends. In short, although we still see upside potential for oil and gas prices, we trimmed our exposure to reflect the supply and demand normalizing. Keeping fundamentals in focus, we believe that a smaller position may be appropriate for today’s current environment.
For more, read our recent blog post, An Intervention for Energy and Oil.
Future Factors
The Real Estate sector in aggregate is juggling low supply, high demand, supply chain disruptions, and labor challenges – all of which are creating short- and long-term price impacts.
New construction has been restricted with supply chain troubles complicating delivering materials, therefore impacting project timelines. Not to mention, the industry is still struggling to maintain an adequate workforce, particularly amid a time of increasing wages.
Our Perspective
Overall, we believe prices will continue to remain elevated as the industry addresses the onslaught of issues. While the supply chain issues should normalize, we anticipate additional factors limiting new construction, including a lack of quality labor and usable land, creating favorable tailwinds ahead.
Unpack more in our recent blog post, For Sale: Real Estate.
| Our View | ||
| Economic Cycle |  |
Growth remains robust, and the economy is in a stable mid-phase of the cycle; many countries are now lapping their massive fiscal spending programs, causing the massive liquidity tailwinds to begin to dissipate |
| Stock Market | |
US stock market volatility has picked back up; equities are at all-time highs, and they remain strongly higher year-to-date; valuations remain a challenge and there are a variety of rising risks that warrant monitoring |
| Bond Market | |
Interest rates have risen well off their pandemic lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads remain historically tight |
| Foreign Exchange | |
While anticipating the dollar may weaken longer-term, in the short-term, it is difficult to make the argument that currencies will swing significantly |
| Important Issues on the Radar |  |
COVID-19: the worst of this economic crisis is behind us, and with multiple waves of the virus, including the Omicron variant, the attention is shifting to vaccine efficacy and distribution; potentially impacting recovery, financial markets and currencies regionally |
| Trade Tensions: relations are in structural decline as China focuses on becoming a self-sufficient, global hegemon, potentially impacting global trade and supply chains | ||
| China Credit Cycle: China is furthest along in its economic cycle; policy tightening may act as a headwind to growth; Evergrande is a major issue | ||
| Inflation vs. Deflation: the significant demand shock and remaining economic slack are disinflationary broadly, but supply chain bottlenecks and rising commodity prices are pushing inflation higher |
*Source: Wall Street Journal, Refinitiv.
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