2021 in review – stepping forward
“It’s sometimes necessary to take a step back in order to take two steps forward”. So said Lenin in the early 1900s. Perhaps the more frequently used expression is “two steps forward and one step back” to indicate progress. At the time of writing both feel like a pretty good summary of where we are as 2021 finishes.
Casting my mind back to this time last year, optimism was definitely in the air. Effective COVID vaccines were being rolled out, economies were recovering strongly, equity markets were bounding ahead and we all looked forward to normal service being resumed in our daily lives.
However, over the last twelve months it has become clear that we’re not completely out of the woods. Many of the worries we had at the turn of this year are still here now: Can we control the virus? Will higher inflation bring tighter monetary policy? Can equity markets continue to rise? Will it ever be safe to book a holiday abroad?
Looking back, 2021 seems to fall into two distinct periods with different market behaviour clearly observable in each. The arrival of the vaccine brought with it a very significant rotation in financial markets. Lockdown and COVID restrictions had seen very strong performance for the “work from home” growth type sectors such as technology, communications (Zoom etc.) and online retailing. With the vaccine news, attention moved to areas closely linked to the reopening of the global economy such as services, transportation, financials and more trade sensitive regions. Our portfolios had positioned for this in late summer 2020 and fared well as a result.
Unfortunately, the normalisation of the global economy and our daily lives was rudely interrupted by the emergence of the Delta COVID variant in Spring 2021. Concerns over economic growth, further lockdowns and supply disruptions reappeared. Once again the “work from home” sectors resumed their dominance. This process has continued apace with the recent appearance of the Omicron COVID variant. Our portfolios have suffered a little as a result of this, but we’re not minded to change our positioning. There’s good reason to believe that this period will be short lived.
In our view, recent market developments are not necessarily supported by the fundamentals within the global economy. Certainly, growth has retreated a little following the extraordinary rebound in the second half of last year. But growth is still very firm, well above trend levels, and the amount of cash accumulated by consumers through the pandemic suggests that stagflation fears are overdone.
Going forward economies will be supported both by consumers spending that cash and corporates once again investing their surpluses within their businesses rather than returning cash to shareholders. That makes for a constructive backdrop for economically sensitive assets which also enjoy some valuation support compared to some of the tech-related market darlings.
Inflation is potentially a fly in the ointment. It’s running at generationally high levels driven by a combination of supply chain disruptions, strong demand and upward wage pressures. Describing inflation as “transitory” was never particularly helpful and mercifully the word now seems to have been retired from the central bankers’ lexicon.
Our view is that inflation is likely to settle at higher levels than the last decade, but not troublingly so. Supply chain issues tend to work their way through in fairly short order, while labour’s position versus capital will limit wage rises over time.
The real issue around inflation is the extent to which it encourages policymakers to raise interest rates and remove the punchbowl that’s been in place since 2008. Rates and bond yields will surely rise in 2022. Changing interest cycles are inevitably associated with periods of market dislocation and volatility. This provides some further support for our decision to avoid the most expensive and vulnerable areas of global markets, many of which will have been the best performers through the pandemic, and through the last decade of low rates.
Once again 2021 has provided further evidence that portfolios are very well served by the foundations which underpin them (the Strategic Asset Allocation). Onto these frameworks we have overlaid a number of important global themes for the long term.
Healthcare is a key one. The ageing of the global population and associated increased spend on healthcare argues for decent exposures here. Increased focus on addressing the impact of climate change at individual, corporate and government levels is here to stay. This presents opportunities which we are keen to take for all our clients, not just those with a specific interest in the area.
Elsewhere bond yields are heading up from historically low levels. For us, many high quality bond areas will remain unattractive for several years. Far better in our view to overlay a defensive selection of alternative assets which can deliver steady returns over time.
On a more tactical basis selectivity has never been more important. We’re nervous of taking unthinking US equity market exposure, where just five stocks account for 25% of the benchmark index. So, we prefer targeted areas that seem likely to do well from the ongoing economic recovery rather than chasing last year’s winners. A more international dimension is also important to recognise both the ever-growing contribution to global growth from emerging markets and the opportunity presented by intra-regional trade in Asia.
Crystal ball gazing is never particularly helpful in investment and it remains baffling to me that so many commentators are preoccupied by neat calendar year assessments. We will always hold true to the principle of maintaining a sensibly spread portfolio combined with an absolute respect for the preservation of capital. Preparing for what the future may hold rather than trying to predict it.
Certainly 2022 will see further challenges from the virus, a changing interest rate environment and lower corporate earnings. We’re ready for those challenges and remain extremely confident that our portfolios are built to last.