What’s next for the markets this year after a rollercoaster 2021?
After a year lost to Covid-19, 2021 began with sense of optimism. By the beginning of last year, several effective vaccines had been approved in record time, economic growth was bouncing back from one of the sharpest recessions on record and stock markets were soaring.
Those vaccines were in the process of mass distribution and the world appeared to be reopening from a healthcare crisis which claimed over 5.3 million lives. The pandemic seemed to be waning as governments around the world invoked various levels of public health policies designed to control the spread and keep the worst outcomes off the table.
The second year of Covid started with alpha, but then switched to a new delta variant, throwing the world a curve ball.
Many countries had to backtrack on reopening plans, even though measures taken during the second and third waves were less restrictive than earlier mandates.
Then, as if on time for this year’s winter holiday season, another highly contagious (but so far less deadly) variant, Omicron, has been spreading wildly.
On top of an extended healthcare crisis, China became a serious nuisance last year. The world’s second largest economy blind-sided investors by launching an attack on the country’s largest and most profitable companies while squashing growth and speculation in its real estate sector. Even smaller companies in areas, such as private education, were slammed by the Communist government.
China’s president, Xi Jinping, seemed to be channeling the late Mao Zedong in his crackdown on capitalism. Adding to China’s woes, Evergrande, a major property developer with liabilities in excess of $300 billion began to miss interest payments and was declared in technical default.
Surprisingly, however, major risk markets constantly shrugged off the bad news and resumed their upward trajectory after each apparent setback.
In 2021, major stock markets climbed the proverbial “wall of worry”. The S&P 500 rose by 26.89 per cent and the MSCI World Stock Index gained 20.14 per cent. Leading sectors were energy, financial services and information technology.
In addition to benefiting from escalating stock prices, many investors saw their net worth gain from rising home prices. Stoked by falling interest rates and quantitative easing (QE) programmes, house prices soared.
The median US home price, for example, rose by an annualised rate of 15.90 per cent last year through November while prices in many cities and regions climbed by much more. Rising home and stock prices led to a marked improvement in household wealth, which encouraged consumers to spend briskly both online and back in traditional brick-and-mortar retail stores.
But not all the news was good news as less developed countries struggled. China’s anti-business initiatives, zero-Covid policy and lack of transparency damaged the emerging market sector as a whole.
Over 2021, the MSCI Emerging Market (EM) index fell 4.59 per cent, underperforming the S&P 500 by more than 31 per cent, one of largest divergences ever. China, still classified as an EM, comprises 33 per cent of the benchmark.
Looking ahead, central bank policies will continue to have great influence on what happens next in the capital markets. But overall, investors should expect less market-friendly programmes.
Some economists think the Fed is already behind the curve in addressing a serious inflation problem. Those analysts believe US interest rates need to be hiked many more times than is currently forecast.
In December, America’s Bureau of Labor Statistics reported that the consumer price index rose by 6.8 per cent, the highest level in 40 years. Supply-chain disruptions, tight labour markets and rising commodities prices were the main culprits.
At December’s Federal Open Market Committee (FOMC) meeting, chairman Powell stated he would double the speed of his original tapering projection. The Fed’s open-market bond purchases, which have been keeping a lid on longer-term interest rates, are scheduled to end sometime next year. After the FOMC’s latest announcement, QE is expected to conclude this spring instead of summer.
Currently high inflation should ameliorate in the coming months, but it will likely stay above what we have seen over the past decade. Although structural issues impacting supply chains have begun to subside and commodity prices have been cooling off, a tight labour market and growing money supply remain serious challenges to capping price rises.
Winners in the new paradigm include market-leading companies which are able to pass along rising input costs. Moreover, sustained negative real (inflation-adjusted) interest rates should continue to push investors into higher-risk assets such as stocks.
The cyclical/value trade was a great place to be throughout 2021 and that’s likely to be the case in the months ahead. In this environment, high dividend-paying companies whose payouts can keep up with rising prices are a good bet.
However, investors should not give up on well-positioned growth stocks. Many high-quality innovative market leaders fell back to earth during Q4’s growth stock correction and some of those companies offer compelling value on a longer-term basis.
A resurgence of the Omicron variant suggests we are still not out of the woods on the public health front. Some technology-enabled growth companies which thrived during the initial lockdowns could continue to see elevated demand if the current situation continues or worsens.
Our sweet spot in this space are growth stocks trading at reasonable prices which benefit not only from an imminent reopening but also secular demand tailwinds independent of the current business cycle. Select companies in the semiconductor, medical device and on-line travel industries fit the bill.
Fixed-income investors had a tough time making a buck in 2021 and that is likely to be the case again in the coming year. With the Fed ending QE sooner than expected and rate rises on the horizon, investors need to careful about extending maturities for higher yield. Old-fashioned laddered bond portfolios represent a smart approach in this environment.
Bryan Dooley CFA is chief investment officer at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult their brokers if such information and/or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.