Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- S&P 500 finishes December up 4.5% and 2021 up 28.7%
- 2021 sees the fourth smallest drawdown since 1987 for the S&P 500 with 70 new highs
- Returns in 2021 were driven by earnings growth with S&P 500 earnings projected to be up 49% year-over-year
- The 3-year total return on the S&P 500 is 100.3%, the highest level since 1999
- The Federal Reserve (“the Fed”) indicates as many as three rate hikes in 2022
Despite huge supply chain disruption, rising inflation and a more-hawkish-than-expected Federal Reserve, the S&P 500 index rose a whopping 28.7% last year and along the way, suffered a maximum drawdown of only -5.2%, the fourth smallest pullback since 1987. Investors who entered 2021 with a bearish outlook never really got their chance to take advantage of any sell-off. There were 70 new highs made in 2021. This is the second-best year for new highs, behind only the 77 new highs made in 1995. Historically, when the number of new highs has been at elevated levels, the market has gone through a stretch in the following years of more new highs. In the year after a +20% return, the S&P 500 on average returned 11.3%, with more than two-thirds of the readings being positive.
The economic and earnings rebound that started in 2020 carried over into 2021, lifting equity markets to record highs. While returns in 2020 were driven by price-to-earnings multiple expansion, returns in 2021 were driven by earnings growth. S&P 500 operating earnings were on track to increase 49% in 2021, with an increase in revenues and profit margins of 15.8% and 28.8%, respectively, according to Strategas. This is an unusually high rate of growth resulting from strong corporate earnings and easier comparisons to weaker earnings in 2020 when the initial shock of the pandemic hobbled businesses.
The celebratory end to 2021 on Wall Street contrasted sharply with the slump felt by millions of Americans contending with the rampant spread of the highly transmissible Omicron variant. As the pandemic enters its third year, the nation is also facing challenges on the economic front, with inflation soaring to near 40-year highs as fresh Covid outbreaks and business shutdowns contribute to supply chain bottlenecks, and worry consumers. But even Omicron does not appear to have dampened the mood among investors as markets continued to exhibit the strength they have shown throughout much of the pandemic, thanks to massively accommodative monetary and fiscal policies.
December Asset Class Performance
All 11 S&P 500 sectors had double-digit returns for the first time on record (since 2001). The top performing sectors in December were consumer staples (+10.5%), real estate (+10.3%), utilities (+9.7%) and healthcare (+9.0%). Each of the sectors, which are viewed as popular destinations during times of uncertainty, outpaced the broader index’s gain of 4.5%. By contrast, energy (+53.3%, a stunning turnaround after a 33% loss in 2020), real estate (+46.1%), financials (+34.8%), and technology (+34.7%) sectors were the year’s best performers. Growth outperformed Value for a record 5th consecutive year. Value outperformed Growth by 4.2% in December but over the full year, the Russell 1000 Growth was up 27.6%, 2.5% ahead of the Russell 1000 Value. The Russell 2000 (an index of small-cap companies) was up 2.2% in December and 14.8% for 2021. International markets significantly underperformed in 2021, with the MSCI EAFE (Europe, Australasia and the Far East) up 11.9% and the China-heavy MSCI EM (Emerging Markets) down 2.5%.
On the monetary policy front, at the November 3rd Federal Open Market Committee (FOMC) meeting, the Fed officially implemented a hawkish pivot when it announced it would start tapering its asset purchase program by $15 billion per month. At its next FOMC on December 15th, the Fed raised tapering to $30 billion per month, which put an end to the repurchase program by March 2022. Between those two meetings, Chair Jerome Powell officially retired the term “transitory” in describing the current inflation outlook. Markets are now pricing in close to three rate hikes for 2022, starting perhaps as early as the March FOMC meeting. The Treasury yield curve was the steepest in 1Q21, indicating little chance of an imminent Fed interest rate hike, before flattening throughout the remainder of 2021 as inflation fears increased. The 2’s / 10’s Treasury spread peaked at 1.58% in March and closed the year at 78bps. The U.S. 10-year Treasury yield closed 2021 at 1.51%. The 10-year yield started the year at 0.91% and hit a high of 1.78% in March. Booming inflation coupled with central banks reversing accommodative policies by turning off the money taps made it a difficult year for bond markets. Long dated U.S. Treasuries – the global benchmark for government debt investors – delivered a loss of around 4.6%, their first red year since 2013. On the positive side, the riskiest subsector of the U.S. corporate high yield bond market – bonds rated CCC and below – have made around 5%. Inflation-linked bonds have also done well, unsurprisingly, with U.S. TIPs returning 6%.
Oil prices (West Texas Intermediate, or WTI) saw a double-digit rally of 14% in December, but the oil sector did not follow through, with a meager 3% return. WTI crude oil price closed 2021 at $75 a barrel. Gold was up 3.1% in December, closing 2021 at $1,829/oz. Gold remains one of the worst performing asset classes in 2021, with a -3.6% return. Bitcoin closed out December with a 19% drop at $46,334, its largest monthly loss since May. Bitcoin’s 60% advance in 2021 marks its smallest gain for an up year since 2015 when it advanced 36%. Bitcoin is notoriously volatile, and this year proved just as choppy as any other. Equity volatility (as measured by the CBOE VIX index) spiked above 30 at the end of November/beginning of December before subsiding to the low 20s in mid-December, closing 2021 at a benign level of 17.2 despite unfavorable Covid data.
Investment Summary – “Inflation, Rates, and Rotation” in an Era of Financial Repression
We will hold our quarterly Investment Committee meetings in mid-January and provide you with a market update in our February 10th Macro & Markets virtual event in addition to an update on our asset class preferences in the February edition of the Pointe of View. In the meantime, we remain slightly “risk-on” (less so versus 3Q 2021) given positive vaccine developments, corporate earnings surprises, reduced risk of a major tax rate hike, and favorable seasonality. We cannot ignore the massive monetary and fiscal support expected now and, in the future, but “stagflation-lite” is a growing concern on a cyclical basis. We prefer Equity and Alternatives to “safe” Fixed Income given the current and expected negative real yield environment. We added to our positions that reflect a rotation from U.S. Large Cap Growth to U.S. Large Cap Value, U.S. Small Cap, and EAFE (growth) given economic reflation. We reduced the allocation to Emerging Markets (EM) equities given our less optimistic views on China and other EMs. We increased the position slightly in short-term bonds to protect portfolios from rising interest rates. We retained the inflation protection position in TIPs but have reduced real assets (gold) while increasing the exposure to hedge funds.
Chart of the Month – U.S. National Debt (Debt/GDP), 80-year History
With the Covid-19 pandemic, U.S. Government debt as a percentage of Gross Domestic Product (GDP) reached the highest level since World War II. High debt levels limit a country’s ability to maneuver when faced with crises. They have also historically been associated with periods of lower growth, reducing the capacity to service debt. Reducing the Debt/GDP ratio requires becoming more fiscally prudent (very difficult politically) OR financial repression. Repression policies that cap rates, coupled with inflation, constitute a subtle form of “debt restructuring” that allows governments to reduce their real debt burden. The observance of negative real interest rates is our best indicator that the U.S. government, amongst others, is implementing policies of financial repression, our current secular (longer-term) investment theme.
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.
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