Fourth Quarter 2021 Market and Economic Review
All things considered, 2021 will show to be a positive year for market growth. The tailing off of investments at the end of the third quarter was followed by an up-and-down fourth quarter.
The uncertainty caused by the Covid-19 pandemic and the new Omicron variant is a leading suppressor to market growth as investors are hit with daily reminders of the virus’ impacts – from returns to border lockdowns in several countries to event cancelations and pleas for vaccination boosters. The impact on the markets is multiple peaks and valleys but a near level growth for the quarter overall.
Domestically, the S&P 500 is still showing solid gains for the approximate 500 largest U.S. public corporations (there are 504 tickers that create the index). The index finished the quarter up 11.03 percent over Q3 and is up 28.7 percent for the year. Yet, this index has been very divergent throughout the year and shows the weight impact of the very largest companies in the U.S.
The 10 largest companies now comprise 31.5 percent of the S&P 500 performance and significantly skew the index’s performance versus all other stocks in the index. These stocks have massively outperformed the average stock in 2021. The Price-to-Earnings ratio (P/E) is a measure of over (or under) valuation of stocks for each dollar of earnings that has also increased. A higher number shows a rich valuation. As of the end of November, those top 10 stocks had a P/E of 33.2 while the remaining stocks P/E sat at 18.7. Going forward in 2022, this also means that these ten companies will need to earn a tremendous amount of money versus other companies, or their stock prices, and the index will underperform.
Smaller U.S. companies mostly continued their downward slide which began in the later weeks of Q3. However, a late surge helped small-cap companies measured by the Russell 2000 index to finish the quarter on a positive note – up 2.14 percent for the quarter. That late push helped the index grow to a 14.82 percent gain year-to-date.
In both cases – large and small company investors – are showing some hesitancy due to the turbulent economic climate which is experiencing the highest rate of inflation in over 40 years.
International markets, like the U.S. small-cap companies, were similarly sluggish for the fourth quarter but saw a late rebound. The MSCI EAFE, which reports on the markets of developed nations in Europe, Australasia, and the Far East, finished the quarter up 2.74 percent after being negative for much of the 3-month period. The year-to-date increase for the index finished at 11.78 percent above its start. Similar investing doubts are casting shadows on these markets compounded by earlier spikes of Omicron and renewed tightening of travel restrictions which could temper activity in the early going of 2022.
The bond markets finished the fourth quarter essentially flat with just a 0.01 percent gain. The Bloomberg U.S. Aggregate now shows a decline of 1.54 percent year-to-date. Overseas bonds were even worse as rising inflation and expectations for rising interest rates created a selling environment. Bonds continue to be a good diversifier and history shows that after the initial anticipation of inflation and rising rates (like we saw this year) they almost always yield a positive return in subsequent years.
* Each benchmark is allocated based on the assumed Risk Profile of underlying indexes.
**Benchmarks include a mixture of ICE BofA US 3-month Treasury Bill Index, Bloomberg Global Aggregate X-US Index, Bloomberg US Aggregate Index, Bloomberg Multiverse Index., Bloomberg US Credit Index, MSCI EAFE Net Index, Value Line Composite Index (Geometric), and the Cboe S&P 500 BuyWrite Index. These benchmarks are the same as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.
As mentioned above, the current inflation rate is running as high as it has in over 40 years. Not surprisingly, the Federal Reserve announced some measures coming out of its December meeting to help combat those rising prices.
The first step the Fed expects to take is advancing its end to the purchase of Treasury bonds. Previously expected to reach zero in the summer months of 2022, they now anticipate reaching that mark by the end of March.
Following the end of its bond purchasing practice, the Fed also expects to levy three interest rate increases in the final three quarters of 2022. At the moment, those increases are expected to be a quarter of a point each and be applied in each of the final three quarters of 2022.
As has been the case throughout the past year, supply chain disruptions are a primary contributor to the rising inflation rates. Shortages of supply and challenges in the labor force are making goods harder to come by. However, consumer purchasing power is still high leading to high demand and generating a perfect formula for inflated pricing.
Looking ahead, many experts believe that the peak of the supply issues for many goods are at (or even beyond) their peak now, and should work themselves out over the first two quarters of 2022. One major exception to that trend is the shortages in computer chips. That industry will likely recover more slowly as some of the correction will rely upon added manufacturing capacity from plants that are either currently under construction or still waiting to break ground.
We hope you had a happy and healthy holiday break with your families. As always, we will continue to monitor portfolios, look for investments that meet our risk/reward targets for each of our clients, and make changes as necessary. Please reach out to us with any questions.