Year in Review – 2021
Despite the desire to leave the pandemic behind, it continued to permeate virtually every aspect of our lives. Individuals, businesses, and governments strove throughout the year to adapt to changing circumstances. Investors were also forced to ponder the effects of the pandemic and to contemplate the ultimate effects on society and finance.
Governments continued to spend lavishly to ameliorate the economic suffering. The Federal Reserve maintained its zero percent interest rate policy and flooded the economy with liquidity. The twin efforts were probably most responsible for the strong moves in investment markets. In addition to the tangible impacts, Federal Reserve pronouncements and policies sent investor confidence soaring to stratospheric levels.
Major Economic Events
The global economy grew rapidly, recovering much of the losses suffered during the first six months of the pandemic. The US government led the world with an extremely robust set of policies, and these succeeded in spurring the economy to remarkable advances. The debts incurred via the stimulus packages have not had any deleterious impact to date. Levels of borrowing have already reached levels not seen since World War II and there seems to be no popular or political will to alter that trend.
The delta variant slowed the recovery, although widespread lockdowns did not occur and economic activity continued. Unemployment fell steadily. A major surprise was the surge in demand for goods that caught manufacturers and suppliers off-guard. Supplies ran short of numerous products, most prominently new and used autos. Inflation spurted higher, although the Fed’s reassurances about the “transitory” nature of the price rises seemed to reassure many at first, and even when “transitory” was dropped from the lexicon, investors barely blinked an eye. The newly emerged omicron variant had little economic impact.
The Equity Markets
American equities had another strong year, propelled by the global dominance of a handful of US firms, aided by a very favorable tax and regulatory environment. Additionally, the pandemic itself fueled the success of these enormous firms and several upstarts, as the technology tools that US based companies dominate became essential to a functioning economy and a healthy populace. The year ended with the various US market indexes nearly at all-time highs.
The American stock market performed far better than its international counterparts, reflecting the strong snapback in the US economy and the exuberance of American investors.
Emerging markets lagged badly and underperformed the S&P 500 by jaw-dropping margins. Some, but not all, of this gap can be explained by covid, which ravaged poorer nations that did not have widespread access to vaccines or the borrowing/spending resources of the wealthier nations. Other wounds were self-inflicted. China, which comprises roughly 40% of the emerging market index, continued its zero-covid stance that restricted economic activity dramatically. A government assault on its home-grown technology firms as well as a crackdown on property firms also took a toll on Chinese equities. Other important emerging markets such as Brazil and Mexico suffered from both the pandemic and misguided government policies.
REITs were very hard hit in 2020 as the future value of much of commercial real estate came into question. The REIT asset class has broadened over the years and now includes sectors such as data centers, warehouses, and cell phone towers and this has helped it become more resilient and less volatile. In fact, several of these sectors benefited significantly from the economic affects of the pandemic and American REITs were the top performing asset class of 2021.
Natural resource stocks benefited from a favorable supply/demand situation. Demand in numerous commodities, in particular oil, took suppliers by surprise and pushed prices higher. Additionally, geopolitical developments are restricting the supply of fossil fuels at a period when alternative energy is not yet able to fill the void.
Overall, the effects of diversification from the traditional S&P 500 index were negative. Small and mid-cap stocks lagged the dominant US firms, and international equities failed to measure up. REITs and natural resources outperformed, and thus provided a bit of a tailwind to diversified portfolios.
The Fixed Income Markets
The bond market rally ended in early 2021 and erased much of the gains from 2020. Prices rallied as the Fed slashed rates to zero percent in response to the crisis, then fell when signs of a strengthening economy resulted in bond investors demanding higher interest rates. The overall bond market experienced a modest loss: -1.5%. Municipal bonds fared a bit better, as the economic impact from covid on state and local budgets has proved to be far less than feared. International bonds fared poorly. The dollar’s rise offset the impact of declining interest rates worldwide. Cash and similar investments remained at rock-bottom levels, in alignment with Federal Reserve policy. Savers will have to wait until 2022 to begin earning interest on their safest investments.