News & Insights
Fourth Quarter 2021 Commentary
Just when we thought things were returning to normal, the Omicron Covid variant reared its ugly head and has sent us all scrambling to navigate this new phase of the global pandemic. Confusion and mixed messages from political and health care leaders has resulted in a complex web of uncertainty about how we should manage work, school, socialization, and basic everyday tasks. However, in spite of the uncertainty and fear, domestic equity markets powered through the fourth quarter on an up note achieving all-time highs during the month of December and finished the year with strong returns and a historically low level of volatility.
The S&P 500 finished 2021 up 28.71% on a total return basis. From a sector perspective, three of the worst performing sectors in 2020; Energy, REITS, and Financials, ended the year as the strongest performers in 2021 (Energy +54.64% / REITS +46.19% / Financials +35.04%). Communication services performed the worst of the 11 S&P 500 sectors but still achieved a 15.96% return for the year. It should be noted that a majority of these returns came in the first quarter perhaps when optimism was highest that the end to the pandemic was near. Although gains at the index level were superb, it is also worth noting just how narrow the market rally was in 2021. In fact, just 10 stocks (MSFT, AAPL, NVDA, GOOG, GOOGL, TSLA, FB, HD, UNH, BRKB) were responsible for approximately 40% of the S&P 500’s positive performance.
Returns across international markets were more muted. Developed international as measured by the MSCI EAFE was up 8.78% on the year and performance varied greatly across regions as each country’s response to rising Covid cases differed significantly. Similar challenges were faced by emerging market countries. The MSCI Emerging Markets Index finished the year down -4.59%. In addition to Covid related issues, Emerging Market economies in the Asia-Pacific region are overwhelmingly influenced by China specific issues. In July, President Xi of China announced several new initiatives that increased the oversight of Chinese internet companies stoking concerns about their future growth prospects and the “investability” of Chinese companies by foreign investors.
Navigating the fixed income markets in 2021 was a challenge. The Federal Reserve kept short-term interest rates near zero as they continued to accommodate the economic recovery even in the face of rising inflation. The Barclays U.S. Aggregate index, which is a benchmark of U.S. investment grade bonds finished the year down -1.54%. Investors willing to accept additional credit or default risk were rewarded as the Barclays High Yield Index finished the year up 5.28%.
Our 2022 Outlook
After two years of uncertainty and lockdowns that resulted in the largest drop in global GDP history, the 2022 economic outlook is looking brighter. Although we do not expect market returns to be as robust as the previous three years, we see the uncertainty around the pandemic fading and our expectations are for further equity market upside and economic growth. Consumers and corporations enter 2022 flush with cash and we anticipate that many of the supply constraints will abate. At the same time, there is considerable pent up demand for services and inventories. This backdrop should support strong corporate earnings growth The below chart from FactSet illustrates the consensus earnings growth estimates for the S&P 500 at over 8% for 2022 which is a deceleration from 2021 but still strong.
However, as you can also see from the graph, estimated and actual results rarely ever align perfectly and there are always some headwinds to contend with.
Heading into 2022, we view Fed Policy adjustments and inflation as the biggest risks to the market. Current policy remains accommodative but ongoing inflationary challenges and a tighter labor market have pushed the Fed into a more hawkish stance. In December, the FOMC announced an increase in the tapering of their monthly bond purchases from $15 billion to $30 billion. This announcement came with a clear acknowledgment that they underestimated the longevity of current inflation pressures. Congruent with this mea culpa, investors are now predicting three rate hikes in 2022. Although this may lead to increased volatility, history shows that the early phase of a rising rate cycle rarely derails bull markets. It’s also important to view these hikes with a wider lens. Assuming the Fed raises rates by 0.25% each of three times over the year, that will bring the target fed funds rate to 0.75% – 1.00%, which is still considerably lower than where it stood in 2019.
While the Fed Policy has been front and center in financial media, another transition that could result in increased choppiness this year are the midterm elections taking place in November. Democrats will most likely face an uphill battle in keeping both the House and Senate. In fact, all 435 member seats are up for reelection this November. Democrats will cease to have the majority should they lose just 5 of these seats And although the data is unclear on which party’s leadership is best for the markets, the potential for a leadership shift has historically led to bouts of volatility. On average, markets have experienced 19% drawdowns during years where midterm elections occur. However, investors have been rewarded for staying invested and capitalizing on market weakness as markets were up 32% on average in the one-year period following the lows.
A question we get often is “When is the next market correction going to occur?” While this is, of course, nearly impossible to predict with any degree of accuracy, we do not expect to see a major correction this year. While volatility is completely normal (certainly we are seeing this unfold in the early part of the current quarter), what is important to focus on as investors is that we see few signs that the current business and market cycles will be ending any time soon. Economic activity remains robust and monetary policy remains easy, both significant in support of higher asset valuations. Inflation continues to be on everyone’s mind, however the typical signs that inflation is contributing to a deterioration in economic conditions – yield curve flattening / inversions, substantially wider credit spreads, and a significantly stronger U.S. dollar – are simply not evident. In our view, any near-term drawdown or correction would likely prove to be a short term deviation of a longer term advance.
As always, we welcome any questions or thoughts and look forward to connecting with you in the New Year.
The Information contained in this document is based on data received from third parties which we believe to be reliable and accurate. YorkBridge Wealth Partners, LLC has not independently verified the information and does not otherwise give any warranty as to the truth, accuracy, or completeness of such third party data, and it should not be relied upon as such. Any opinions expressed herein are our current opinions only. YorkBridge Wealth Partners, LLC is an SEC Registered Investment Adviser under the Investment Advisers Act of 1940 (“Advisers Act”). Registration of an investment advisor does not imply any specific level of skill or training. The information contained in this document is to assist with general planning. Please consult with your own tax advisor and attorney for more specific information.