After a difficult September, the equity markets finished the year strongly led by giant technology companies like Apple, Microsoft and Alphabet (Google) as well as real estate, materials, consumer staples and consumer discretionary sectors.  Small capitalization companies performed relatively poorly as investors sought the safety of large cap names.

While our portfolios are invested substantially in stocks of domestic companies, we are also invested internationally with exposure to Europe and emerging markets.  The S&P 500, which is an index of 500 of the largest publicly traded companies in the United States was up about 27% for 2021. European markets performed well, but meaningfully lagged US markets.  Emerging markets, which have substantial exposure to China, were basically flat on the year with China down significantly due to some of the regulatory actions of the Chinese government discussed in last quarter’s letter.  We also diversify against inflation through small positions in precious metal ETFs.  They have historically been an effective hedge against rising prices but were down for the year. 

Clean energy investments in solar, wind and electric storage and vehicles, which have been a theme in my writings and are a part of our client portfolios had a difficult year after a tremendous year in 2020.  2020’s appreciation could be attributed to the anticipation of a Biden victory and the promise of green energy investments to combat climate change. Political reality and the failure to pass even a scaled down version of the build back better may have contributed to the decline in the market valuations of the companies in these industries. Conversely, fossil fuel companies as a group performed quite well in 2021 as the price of fuel skyrocketed after suppliers cut production due to the pandemic induced shutdowns yet consumer demand and economic recovery strongly returned earlier than expected. Despite the large gains in fossil fuel stocks during 2021, they are still down over the last 3 and 5 years.    

Year over year inflation numbers came in at their highest levels in nearly 40 years during the fourth quarter and got the attention of the members of the Federal Reserve, who are charged with addressing both inflationary and employment pressures.   As mentioned in financial media ad nauseum, contributing to the continuing inflationary pressures are supply chain glitches, semiconductor shortages, and a tight and ever more expensive labor force. Just this week on January 5th, the Fed Board’s meeting minutes suggested they would be more aggressive on the inflation front by reigning in their balance sheet and potentially raising interest rates sooner than many market participants had expected.  Not surprisingly the markets took a nosedive after those minutes were released.

Wall Street pundit projections for the markets in 2022 are as usual spread across the board.  Many investment managers are predicting a good year for value stocks versus growth stocks, which may just be a hope for reversion to the mean after years of growth’s outperformance.  Higher interest rates do tend to favor value stocks which have solid current earnings.  Growth stocks tend to be negatively affected because the present value of earnings discounted further into the future are adversely affected by higher rates (higher discount).  Given the likelihood of higher interest rates in 2022, value investors may finally be on the right side.

Bond markets continued to go sideways as the prospect of higher interest rates made bonds unattractive.  Also, because companies were so profitable last year, investors had minimal concerns about the potential for default.  Bond pricing is normally based off a combination of the risk-free rate for the duration of a given issue as well as a premium for the risk of default, or bankruptcy. Given low interest rates and perception of minimal risk to principal, bond yields on corporate issues remained unattractive throughout the year and due to inflation, the real return (adjusted for inflation) made bonds, like cash, an asset class of declining purchasing power.   As expected in an environment like this, bonds were generally down during 2021, with the exception of Treasury Inflation Protected (TIPs) issues which rallied as inflation reared its head. 

I wish you and yours a Happy, Healthy and Prosperous New Year.  Should you have any questions about the attached report, this email, your portfolio, or anything else related to your financial life, my line is always open.

Best regards,

Steve