Review of 2021 and the Outlook 2022

Introduction

2021 has been an extraordinary year. It began with great optimism as Investors and analysts expected that the roll-out of the recently discovered Covid Vaccines would result in a gradual normalisation and opening of the economy.

The Vaccine rollout has been quite successful at least in many of the developed countries but the return to normal has proved to be elusive. In particular, global supply chains which have delivered just-in-time distribution in recent decades, have been heavily disrupted and this has contributed to a rise in inflationary pressures as goods prices in many categories have risen very rapidly.

The end of lockdowns did not increase the labour supply as people did not re-enter the labour markets in the numbers that were expected. Companies in the developed world struggled to hire workers and had to raise wages and try more innovative methods to attract staff. Wage pressures increased and added significantly to the global inflationary pressures caused by the fractured supply chains.

At the first serious signs of inflation for nearly a decade, global central banks initially said the inflationary pressures were transitory. However, in early December, the head of the Federal Reserve, Jerome Powell seemed to change his mind a few days after President Biden had renewed his position as Fed Chairman for another four years.

The Fed had already started tapering its bond purchases and markets assumed that the Powell pivot on inflation would slightly bring forward the day when US interest rates would have to rise. These expectations have put upward pressure on Bond yields but at the time of writing (mid-December) government bonds have rallied strongly.

The supply chain problems and the re-emergence of the global economy from Covid lockdowns led to increased demand for Commodities and boosted commodity prices which also added to the increased inflationary pressures noted above.

The Markets in 2021- Buffeted by Covid

Equity Indices

Investors who took risks in 2021 were greatly rewarded as huge liquidity prevailed after a decade of low-interest rates boosted asset prices. As the table below shows, most indices rose over the year.

This data shows the US performed strongly, other developed markets are also in positive territory but emerging markets as a whole fell, though India’s Nifty was one of the best performers with an advance of 18.9% in USD terms year to date.

The heatmap below shows the performance of the stocks in the S&P 500 year to date in USD terms.

The Map Highlights Two Key Features:

• Large-cap stocks particularly in technology have risen strongly as most of the large boxes are shown as green.
• Very few stocks have fallen as few boxes are coloured red.

However away from the Index, many stocks which had been hyped and had been flying high fell sharply in the second half as their quarterly numbers
in the autumn disappointed market expectations. Stocks such as Peloton, Zoom and Roku fell between 30% and 70% during 2021.

Indeed as the chart below shows, if one discounts the top five largest stocks, the Nasdaq would have been deeply in negative territory in 2021 YTD.

So this shows that the breadth of the market has been weakening especially in the last three months.

In contrast to equities, 2021 has been a poor year for bonds. Most bond strategies have given a small negative return in the USD term (around -1% to -2% this year). The two main notable exceptions are US High Yield bonds which are up 2.7% and EM bonds which as an aggregate are down about 6% in 2021 (YTD).

2021 was a good year for Commodity investors. The Bloomberg Commodity Index has risen 20% in 2021. Oil prices rose 48% over the year. Gold prices fell 5% over the year.

Bloomberg Commodity Index in 2021 YTD

West Texas Intermediate Oil Futures in 2021 YTD

Spot Gold Price in 2021 YTD

Market Outlook for 2022 – Back to Normal

2022 will be a year where we should go back to normal in that Covid fears will subside, interest rates will rise to more normal levels, many speculative bubbles in assets will deflate and more normal investing rules will prevail and more familiar investing conditions will be restored.

2022 will be a year of higher inflation and rising interest rates. It is also likely to be the year when we really can assume that Covid is in the rearview mirror if vaccination rates in poor countries finally pick up in a meaningful way.

Interest rates will rise a little in 2021 in most countries though they will remain low in historical terms. This means that bond investors must be cautious given the likelihood of higher interest rates. Investors should limit themselves to IG bonds and Crossover of shorter maturities (less than five years). As interest rates and money gradually becomes tighter, many hyped up and speculative assets such as Cryptocurrencies, NFTs, Meme Stocks, other alternative assets and growth stocks where there is little sign of positive free cash flow or profits will all decline, perhaps quite sharply. This deflation of various speculative bubbles is both healthy and necessary.

Inflation generally tends to favour equities over bonds providing the correct stocks are chosen. In particular, equity investors have to be even more careful to choose companies that have pricing power, strong prospective earnings growth, high returns and durable business models. These are the kind of companies that can outperform well in inflationary conditions.

In terms of geography, we will continue to favour the US Market as that has performed well over the last five years while selectively looking for good companies in the UK, Europe, India, Japan and South-East Asia and on a very selective basis in other emerging markets.

In terms of sectors, we believe sectors such as Technology, Financials, Industrials, Consumer Discretionary, Healthcare will continue to be favoured. As markets finally discount Covid as a serious factor “re-opening” sector such as Airlines, Travel, Leisure, Hotels and Cruise Lines should perform well. As the global economy opens up, commodity prices will remain elevated.

No matter, what happens in the markets in 2022, we look forward to discussing market conditions and opportunities with you and to help you guide you through the market storms.