Happy New Year to you and your loved ones. I hope that you had an enjoyable festive season.
It has been a while since I penned an update and, as always, plenty has been going on in global financial markets to keep investors on their toes.
Since I last wrote to you, Avellemy made a major new appointment and I am delighted to welcome Graham Bentley as our Chief Investment Officer. Many of you will be familiar with Graham’s monthly market updates, through which his knowledge and experience are evident. Graham and I will be filming a short video outlining our key investment themes to watch in 2022, so keep your eyes open for that.
Whilst 2021 was a good one, in terms of market returns, it was also a year during which many active managers struggled to capture outperformance. Markets were driven by the outlook for inflation and the ongoing global pandemic. The charts below clearly show how market capitulation from “growth” to “value” or economically sensitive (cyclical) stocks to defensive ones, and back again, was highly correlated with the development of the pandemic:
These sharp and frequent rotations through 2021 made asset allocation and security selection highly challenging, to say the least.
The latest spike in global Covid cases in the charts above was driven by Omicron, which appears to be highly transmissible but, for now, also seems to cause less severe illness. Now, that it is a huge generalisation as the severity of illness will vary according to demographic cohort. Nonetheless, the market would appear to be buying into this narrative for now.
Despite Omicron roiling markets in late November, we saw the much talked about “Santa rally” in US equity markets in the final days of 2021.
During the first trading week of the new year, the dominant theme in markets has been a sharp increase in government bond yields in both the US and UK. As a reminder, bond yields have an inverse relationship with their capital values and so values have fallen:
The predominant drivers of the latest volatility in Government bond markets appear to be the recently released minutes from the last Federal Open Market Committee (FOMC) meeting and optimism around Omicron.
The FOMC meeting minutes were more hawkish than many market participants expected and the first interest rate rise from the US Federal Reserve is now priced in for March this year. This expectation has been consistently brought forward throughout the course of 2021 but the latest comments from the FOMC, combined with high inflation numbers, and a more aggressive tapering of bond purchases by the Fed (QE) have caused the sharp back-up in yields shown above.
One thing that is worth pointing out is that a slowing in the pace of bonds purchase by a central bank does not mean that financial conditions are getting tighter and the liquidity is being removed from the system. It means that liquidity (cash) is still being pumped into the financial system but at a much slower rate. Nonetheless, market volatility is, I fear, likely to be a feature of markets in 2022.
The bond market dynamics discussed above have caused, yet another, market rotation from “growth” to “value”. The charts below show that, over the very short term, “value” has outperformed “growth” by some margin in the US and the UK has outperformed the US, due to its heavy weighting in so called “old economy” industries such as Oil & Gas, Financials and Industrials:
Whether this trend continues into 2022 or not remains to be seen.
To me, this feels extraordinarily similar to the beginning of 2021. A year ago, many people were calling the US equity market, particularly Technology stocks, overvalued and were calling for the US equity market “bubble” to burst. Many commentators also called for a stellar year of returns from “value” stocks in 2021.
To be fair, “value” did outperform “growth” and the old economy markets such as the UK and Europe did outperform the US for a while. But then came Delta and the trend rapidly reversed.
I, for one, am hoping that 2022 will not be a replay of last year. However, risks to financial markets remain numerous. The apparent assumption that Omicron is the last variant of any real concern feels like a big leap and it would be prudent to remember that new Covid variants are a real risk. The first interest rate rise from the Federal reserve is imminent and highly likely to cause yet more volatility in markets. Thankfully, whilst past performance cannot be used as a guide to the future, history suggests that any set-back caused by the first rate hike should be fairly short lived.
Until next time, stay well.