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Q4 2021 Commentary

Jordi Visser

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2021 finished with stocks making all-time highs, again, and bonds posting a rare negative annual performance. Despite worries over stock market valuations, the S&P 500 Index finished the year up near 29%. Over the last three years, which included a pandemic, a severe recession, and the highest inflation since the 1980s, the S&P 500 before dividends compounded a 90% return. Aside from the 1990s, you have to go all the way back to the 1930s, when coming out of the Great Depression, to see returns over a three-year period that compare to the returns we have observed in this cycle. These outsized gains, combined with increasing volatility of volatility within equities, have investors worried about a possible end to this regime.

To make the investment environment even more difficult, bonds appear unable to offset the problem. The Bloomberg US Aggregate Bond Index had its 4th negative year and 3rd worst going back to 1977. Corporate credit spreads ended 2021 near the tightest of all time. The final report of the Consumer Price Index for 2021 posted the highest level since 1982. Finally, US 10-year rates finished near 1.5%, with real yields down at -5.3%.

In 2022, we expect inflation to remain stubbornly high. Consequently, the Fed is expected to start a tightening cycle. Bond volatility is likely to remain high and stocks have been driven higher by growth in the M2 money supply from ~$15 trillion pre-Covid to ~$21 trillion at year end 2021. With all of these factors, it is not surprising that many of our investors are searching for solutions to navigate a unique market environment and pressure on fixed income portfolio is becoming a central theme.

It’s important to emphasize that 2021 was a particularly hard year for fixed income. In 1Q 2021, the rise in yields led to the worst quarterly performance for Investment Grade bond indices since the third quarter of 2008 following the Lehman Brothers collapse. Additionally, the Bloomberg US Aggregate Bond Index had its worst quarter since the third quarter of 1981. Despite a modest recovery in the second quarter, fixed income sold off violently beginning in September 2021 and continued into the end of the year. The negative performance witnessed in 2021 by fixed income benchmarks followed 2018, when the Bloomberg US Corporate Bond benchmark precipitously dropped -2.51%.

2021 was a difficult year for many investors as strong economic growth accompanied continued uncertainty about the COVID pandemic, rising inflation, and volatile yields. Unfortunately, we expect 2022 to offer more of the same volatility and uncertainty rather than a return to more familiar trends.