Dear Friends,
2021 will be remembered as the year of a massive rebound and recovery from the depths of the pandemic which broke out in the first quarter of 2020. The first half of 2021 saw the introduction of effective vaccines and the continued reopening of the economy. In addition, trillions of dollars were pumped into the economy from unprecedented fiscal stimulus (government checks, forgivable loans, etc.) and monetary policy (super low interest rates and billions of dollars of bond purchases by the Federal Reserve). The combination of these factors led to extraordinary economic growth but also to supply chain bottlenecks, labor shortages and significant increases in the price of many/most goods and assets (consumer and industrial goods, residential real estate, stock prices, etc.). Interest rates rose modestly through the year but not nearly enough to keep up with inflation, which has reached as high as 7% recently.
Fueled by the combination of economic recovery and the massive injection of liquidity, financial markets were generally good in 2021 although returns varied widely depending on asset class, industry sector and geography. In the U.S. large cap stocks (S&P 500) returned over 25%, but small cap stocks only returned in the mid-teens. Foreign stocks in total returned about 8% and were weighed down heavily by poor performance in emerging markets. For example, Chinese stocks were down more than 20% for the year. Bond markets were flat to down 1-2% for the year as modest price decreases offset the income from bonds. Keep in mind: interest rate increases lead to lower bond prices and vice versa. Due to heavy demand and supply chain bottlenecks, most commodity prices increased substantially in 2021 although precious metals like gold and silver were down for the year.
What’s the outlook for 2022? The good news is that our economy remains strong, and, while growth will probably decelerate vs. 2021, we still anticipate healthy economic growth in 2022. We’d like to think that the underlying strength of the economy will ultimately provide a rising tide for investors. Having said that, we anticipate a more challenging environment for investors this year. We’ve had three consecutive years of excellent returns in the stock market and have not had a “normal” correction since 2019 (we don’t consider the March, 2020 selloff to be normal). Valuations in the stock market are historically high, fiscal policy is more restrained, and the Fed is in the early stages of tightening monetary policy (higher interest rates, less liquidity). So we are past due for a correction ….but we don’t believe that is something to be feared. We would be fine with modestly higher interest rates, lower inflation and a healthy reset of stock prices. And as usual, we would be buying stocks on weakness.
We are not making dramatic moves in our portfolios but are repositioning our equity allocations to be slightly more defensive going into 2022. We see high quality companies and sectors with more reasonable valuations outperforming in the near term (this already started happening in the very first week of this year). In the bond market, patience is required. If rates continue to rise, we probably get another year of flat to slightly down returns. However, we appreciate the ballast that bonds provide in a diversified portfolio and don’t believe it’s prudent to abandon them. Going into 2022, we have positioned our fixed income allocations towards lower duration bonds and other sectors that are less exposed to rising rates. Keep in mind that on the other side of a rate hike cycle, bonds will actually be more attractive and that should be a good thing for diversified portfolios.
All in all, we’re thankful for where we are: coming out of a pandemic (is it over yet?), having had a great run in the financial markets, and are especially thankful for our amazing clients .We love working with you and always appreciate your encouragement and support. Let us know what we can do for you.
Matt and Andrew