4Q21 Market Overview
As U.S. inflation reached 7% on a year-over-year basis, concerns lingered about whether this was the result of a transitory rebound or new normal. To calm fears, the Federal Reserve provided greater insight into removing stimulus and raising interest rates to combat inflation. In the end, global corporate profit results overshadowed concerns and the surging Omicron variant to lift global equities in the final quarter and top-off an impressive year that exceeded all expectations.
Moving forward, attention will continue to focus on equity market valuations and whether corporate profits and economic growth can keep pace with projections. Visible challenges in the new year will include elevated inflation, Covid-19 vaccination adoption rates, mid-term elections, and tighter monetary policy. Regardless of the market direction, our disciplined process will utilize market changes to shift towards our target allocations in the most tax-efficient manner possible while maintaining your desired risk level and fulfilling your cash flow requirements.
U.S. Equity Markets
U.S. equity markets finished the quarter with an impressive gain of 9.3% for the Russell 3000 and exceptional full year return of 25.7%. Higher inflation, persistent supply chain issues, tighter monetary policy guidance and rising Omicron cases were not enough to detract from strong corporate earnings. The positive earnings surprises throughout the year lifted markets and exceeded all expectations. Taking a deeper dive into the U.S. equity markets reveals that large cap equities significantly outpaced small cap equities which returned 2.1% for the Russell 2000 during the quarter and 14.8% for the full year. In November, President Biden signed the long-awaited $1.2 trillion bipartisan infrastructure bill to upgrade the transportation sector, improve water and power infrastructure with other funds allocated to broadband and the environment. The more ambitious Build Back Better spending bill which would have been more costly from an individual tax perspective couldn’t assemble a majority in the Senate and ended up failing in December without Joe Manchin’s help. Even without the additional economic stimulation from the second bill, most economists believe that a financially healthy consumer with elevated cash levels, the lowest household debt to asset level since 1973, will continue to consume and support the U.S. economic growth trajectory. This expansion should continue in the new year, especially if Covid-19 and inflation can be contained.
International Equity Markets
International developed equity markets finished the quarter with a 2.7% gain for the MSCI EAFE and positive annual return of 11.3%. Although Eurozone gains were positive, inflation, unstable gas prices and supply chain issues weighed on markets early in the quarter. Solid corporate profits and economic resilience in the eurozone helped offset these headwinds and new Omicron variant worries to finish the year with positive momentum. Japan’s October elections took a toll on markets with a negative -1.7% return for the quarter even though Omicron infection rates remained much lower than other developed countries. Japan’s political focus has turned to a significant fiscal package to boost personal consumption in 2022. This news along with a surprising pick-up in auto production after a temporary set-back tied to the semiconductor shortage should help their economic and equity market recovery. The MSCI emerging markets lost -1.3% during the quarter and -2.5% for the full year with China accounting for most of the underperformance. To help overcome China’s regulatory tightening, China introduced other supportive monetary and fiscal measures which should turn this negative trend around in the new year. Both developed and undeveloped international markets look more attractive from a valuation perspective compared to U.S. markets.
Fixed Income Markets
Safety-minded investors experienced flat results as the closely watched Barclays Aggregate gained 0.01% during the quarter and posted a -1.5% loss for the full year. Due to a tight labor market and inflation concerns, the Federal Reserve recently announced that it will double its tapering asset purchases and prepare for up to three interest rate hikes in the new year. The 10-year Treasury yield initially rose during the quarter before finishing exactly where it started at 1.52% on December 31. For the full year, the 10-year increased from 0.93% to 1.52% leading to broad annual fixed income market losses. Without any 10-year yield movement over the past three months, it seems surprising to see sharper movements in the short to long term duration bonds until you factor in Federal Reserve guidance and inflation expectations. The Barclays US Government Long posted a 3.05% quarter gain, Intermediate -0.58% loss and Short -0.58% loss. This was a rare quarter in which 3-year yields increased from 0.53% to 0.97% and 30-year yields retreated from 2.08% to 1.90% on December 31 which supports the return deviation compared to the 10-year yield. In the international fixed-income arena, the JPM Non-US Unhedged lost -1.8% and more damaging full year loss of -9.5%. The Barclays Municipal outpaced other indices to finish the quarter with a gain of 0.72% and annual return of 1.5% as demand remained strong.