Q4 was another strong period for portfolios capping off a good year for investors.
Global equities had a strong fourth quarter with equity markets in the US up 10.6%, in Europe up 6.4% and in the UK up 4.2%. However, a weakening Euro meant UK equities outperformed their European counterparts in comparable currency terms. The US dollar maintained its strength and was therefore the best performing major equity market in the period. Mainland Chinese equity markets gained 1.4% and while Japan fell 2.2%, both achieved positive performance in 2021. Hong Kong fell a further 4.8% and was the only major equity market to suffer a negative year.
Government Bond yields
Government bond yields ended the quarter relatively unchanged with 10-year US Treasuries rising to 1.51% from 1.49% and UK Gilts rising to 0.97% from 0.93%, but their peaks and troughs highlighted the key events during the quarter. The persistence of inflation was the key focus in October with US CPI remaining elevated at 5.4% (year-on-year) and the energy crisis pushing Eurozone CPI to 4.1%. At the same time, wages were beginning to creep higher; up 5.5% (YoY) in the US, which was still suffering from worker shortages, despite a reduction in unemployment benefit. At their peak, Treasury yields reached 1.7% while Gilt yields reached 1.2%. Supply chain issues remain heading into 2022.
By mid-November, Treasury and Gilt yields had fallen as far as 1.35% and 0.70% respectively, as the Omicron variant emerged and potentially halted central bank plans to tighten policy.
The world is in a far different place to where it was in March 2020 and a lightning-speed roll out of booster vaccines looks to have curtailed its impact while allowing for more lenient lockdown measures. We know Omicron is more transmissible, one study suggesting 70x more so than Delta, and it appears to be less virile, but we have yet to see conclusive data. Now the world is experiencing a surge of active cases while severity and deaths have remained much lower, giving hope that this could be the waning of the pandemic. In the near-term we are likely to see some stress in healthcare systems. Should we experience further variants of concern, we can be confident in Moderna’s capacity to design and produce new vaccines at a rapid pace; now estimated to be a 100-day cycle which would be 3x faster than in 2020.
Markets have been dominated by the excess liquidity and the ‘lower for longer’ rate environment theme for most of the post-pandemic era, but the pendulum is beginning to swing the other way. Recent Bloomberg surveys confirm that Federal Reserve policy tightening is now considered the biggest tail risk facing investors, ahead of inflation and Covid. Jerome Powell dropped the word “transitory” when referencing inflation as the Federal Reserve provided multiple indications that its ultra-easy monetary policy is coming to a close. Monthly bond purchases have been halved and the median expectation is for three rate hikes in 2022. The US dollar has rallied in response, various commodity prices have rolled over and, in a more nuanced move, yield curves have flattened.
Tightening policy should be a headwind for investors but in absolute terms the policy shift is still quite dovish and, even with the measures proposed for the year ahead, real rates will be dramatically negative. The challenge for The Fed is to allow rates to gently rise without instigating a blowout or shock. In Europe, the ECB is expected to be much looser with its policy having left rates unchanged while the Bank of England is expected to occupy the middle ground having already raised rates by 0.15%. China, in contrast, may have entered another easing cycle after cutting reserve requirements to boost its ailing economy.
There is still potential for an inflationary environment unlike one we have seen in recent history, and we are positioning portfolios to provide more protection in this environment; Gold and other alternatives including commodities may prove to be better stores of value than Bonds. Our longer-term strategy is to maintain exposure to assets that incorporate strong ESG principles into their activities. In the near term, we expect value stocks to outperform growth stocks. whilst markets are likely to have periods of volatility, against a background of continued economic growth, this will throw off investment opportunities for portfolios in the year ahead.
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