Q4 2021 Market Commentary

    Despite the continuing pandemic, 2021 was terrific for US equities as the S&P 500 rose 11% in the 4Q and finished the year up 28.7%. It wasn’t just large-caps that did well as the Russell Midcap Index gained 22.6% and the small-cap Russell 2000 Index closed out the year with a very respectable 14.8% return.

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    Given the fact that inflaction had been a growing conern for most of 2021, it’s not surprising to see REITs and commodities – two asset classes that tend to perform very well in inflationary environments – at the top of the list of best performers last year, returning 41.2% and 27.1% respectively. Although US      equities have achieved a rare occurrence, three consecutive years of double-digit returns, non-US stocks remain laggards, with the MSCI All-Country World  ex-USA Index garnering a modest 8.3% return in 2021 and the MSCI Emerging Markets Index posting a -2.2% decline for the year.

    In stark contrast to most equity markets, fixed-income securities experienced a fairly disappointing 2021. The bellwether Barclays US Aggregate Bond Index was down -1.5% for the year, marking just the fourth negative annual return since its inception in 1970. International bonds fared even worse as the Barclays Global Aggregate Bond Index declined by nearly 5%. US high yield bonds were the relative winner gaining 5.3% for the year, which makes sense since they’re highly correlated with US equities.

    Turning our attention to 2022, with the advent of a new year, we can expect to see the usual deluge of market outlooks and annual forecasts from Wall Street strategists. And at this time I always recall more than one such strategist privately confessing that they hated putting together these outlooks, admitting it was more or less educated guesswork trying to predict what would happen during the year, but that they were pressured to do so because clients expected it. In fact, a good argument can be made that it’s easier to predict what will happen either next week or in ten years than it is to forecast what will occur in the next twelve months.

    That said we will venture to make three “educated guesses” about 2022: 1) market volatility will increase, 2) economic growth will slowdown, and 3) inflation will recede. As for volatility, since 1928, corrections of at least 10% have occurred in the S&P 500 on average 1.1 times per year. Through 2021,
    the last time the S&P 500 suffered a drawdown of at least 10% was in June 2020, or about 18 months ago, so a meaningful correction is overdue.

    It’s worth reminding that at any point in time, we can always put together a list of several things to worry about when it comes to investing in the stock market. If we always allowed any of these things to overly concern us, we’d always be 100% in cash. In fact, there’s much truth to the sayings, “bull markets climb a wall of worry” and “bear markets slide down a slope of hope.” More often than not, the time to really worry about a bear market developing is when there’s no perceived signs of a bear market occurring. During such time, investors are usually very optimistic and hopeful about the future, arguably too much so, as they tend to quickly dismiss any arising bad news as no big deal. Complacency sets in and any market decline is seen as a time to blindly step-in and “buy the dip.” A textbook example of this environment was during the tech-bubble of 2000, when the internet was expected to revolutionize everything and equity valuations were all but ignored.

    Granted, the last 18+ months have been extremely bullish for US equities and perhaps investors had become too comfortable with the idea that the Fed
    will always save us. The Fed’s ballooning balance sheet and maintaining low interest rates, along with the federal government’s COVID-related fiscal stimulus, provided an unprecedented massive injection of liquidity which propelled markets higher. But all of that is now past history as the Fed is facing
    a reversal in its easing stance to combat stubborn inflation and any aid from the government is drying up. With the prospect of tighter monetary policy this year, investors will be re-calibrating valuations, which for many sectors had become quite bloated.

    As mentioned, the massive stimulus coming from both the Fed and the federal government – fueling record-setting growth rates since the start of the pandemic – will be winding down this year. The shrinkage or tightening of such unprecedented liquidity will likely result in the slowing of the economy.
    This expectation does not necessarily mean a recession will occur; in fact, leading economic indicators currently show no evidence of a recession on the horizon. However, it stands to reason that lacking exorbitant fiscal and monetary stimulus, economic growth should moderate and return to levels of normalcy.

    Assuming that the economy does indeed slow or decelerate, it should serve as a tailwind to help alleviate inflation. Typically a primary reason for rising prices is strong demand for goods and services as a result of a rapidly growing economy. In our current situation, along with extraordinarily high consumer demand, the catalyst for inflation has been further compounded by widespread supply-chain bottlenecks. However, such bottlenecks won’t last forever, and there’s already indications that supply-chain disruptions are easing which should translate into diminished inflation.


    The chart above shows the Baltic Dry Index (BDI), which tracks the cost of shipping commodities and raw materials. As the duration of the pandemic extended, leading to an increase in bottlenecks, shipping costs increased as reflected by the BDI rising by nearly 800% from May 2020 to its peak in October of last year. But since then the BDI has plummeted by more than 60%, inferring the supply-chain crisis could be abating and normalizing.

    Another hopeful sign of inflation dissipating in the near future is shown in the chart below:


    The ISM prices paid index (blue line) measures how much manufacturers are paying their suppliers and it tends to lead inflation (CPI, red line) by about three months. Note that the blue line peaked last year and since then has been heading south, suggesting inflation should likewise recede over the next several months.

    Finally, although we do expect market volatility to pick up this year, the following exhibit serves as a sobering reminder that corrections, while painful, are not out of the norm and should not be a cause for panic. Since 1980, the average correction for the S&P 500 has been approximately -19% and 1-year later the index has gained on average about +25% from the lows 90% of the time, and after two years has risen by +37% off the lows about 87% of the time.

    The team at Measured Wealth wishes you all the best during the rest of 2021. As always, if you have any questions, feel free to call or email.

    Ed M Signature




    Ed Miller, CFA, CMT
    Chief Investment Officer
    Measured Wealth Private Client Group

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