Candyland
SUMMARY
Markets are like little kids. They want candy, and the minute you try to take the candy away, they have a tantrum.
– Mohamed El-Erian, Chief Economic Advisor at Allianz, 2021
INFLATION THEME
The lifecycle of a theme: from “your fears are unjustified” to “why did almost no one see inflation coming?” in less than 12 months
4Q, 2021 MARKET REVIEW
A generally strong quarter for risk assets, especially U.S. REITs and large cap stocks; balanced U.S. portfolios returned 4.1%
SUMMARY
LONG-TERM ASSET CLASS RETURNS
Key markets near all-time highs with inflation running well above “target” exposes the impossible challenge policymakers face
ASSET ALLOCATION VIEWS
Remain diversified and tilted for upside inflation risks (value equities, lower duration bonds, overweight real assets and opportunistic)
GROWTH, INFLATION & POLICY
My Democratic colleagues in Washington are determined to dramatically reshape our society in a way that leaves our country even more vulnerable to the threats we face. I cannot take that risk with a staggering debt of more than $29 trillion and inflation taxes that are real and harmful to every hard-working American at the gasoline pumps, grocery stores and utility bills with no end in sight.
– Joe Manchin, Unites States Senator and Democrat, West Virginia
GDP & INFLATION
Growth and inflation both expected to slow, but to remain above average for next several quarters
U.S. BUSINESSES
U.S. durable goods orders reached a record as demand remains strong; retailers have struggled to build inventories to match demand
U.S. HOUSEHOLD INCOME & GOVERNMENT TRANSFERS
The reliance on government transfers over the last few years was astonishing; the hangover from this ending could be harsh
DEBT SERVICE & REVOLVING CREDIT
As transfer payments have waned, the consumer has started to dial up leverage, but plenty of room to go...
INFLATION TRENDS
Inflation is surprising forecasts on a global scale, a first since 2009
Inflation and inflation expectations are still somewhat contained, but any increases would pose a significant risk to the economy and markets
THE 2-YEAR TREASURY
Watch the Treasury market for policy changes: the 2-year Treasury tells you everything you need to know about pending Fed decisions
CPI & HOUSING
Adjusted for U.S. housing price appreciation, inflation would be significantly higher due to the lag in reporting of shelter in CPI
U.S. LABOR MARKET
Job quits rise, openings fall as restaurants struggle with COVID-19 policy response to rising cases
LABOR MARKET DYNAMICS
Companies getting creative in attempts to attract workers in a challenging labor market environment that is very different from the ‘09-’11 recovery
COVID ENDEMIC
Whether by vaccination, prior infection or both, more than 90% of the population could have a form of immunity
COVID TRENDS
The reaction function and policy response to the pandemic has been significant and unpredictable; Omicron disruptions seem to be waning
TRANSIT ACTIVITY
“Back to work” hasn’t gone according to plan
ENERGY PRICES & SENTIMENT
Rising energy prices will continue to be a hot topic for consumers and the current administration
MONETARY POLICY & GLOBAL STOCKS
Global quantitative easing efforts supported the recent gains in global stocks
MONETARY POLICY
Thinking well ahead, if the Fed ever does need to reverse course, they have substantially more options than the ECB and BoJ
EQUITY
Right now, we’re in a raging mania.
– Stan Druckenmiller, Investor, 2021
MARKET RETURNS SUMMARY
U.S. large cap stocks outperformed during the quarter; U.S. valuations remain higher than international and emerging markets
Earnings grew at a faster rate than returns in 2021, resulting in multiple compression in the S&P 500
GLOBAL EPS
Global EPS growth expectations have slowed; U.S. growth is expected to be higher than the rest of the world in 2022
COVID TRADE
Quarantine stock basket now trails the broader U.S. stock market over 24 months
NASDAQ BREADTH
Just 30% of the NASDAQ 100 trades above their 200-day moving averages
VALUE VS GROWTH
Growth price optimism not supported by earnings
SMALL CAP VS LARGE CAP
Historically small cap has been more expensive than large cap, but small cap relative valuations are currently near the lowest levels in recent history
VALUATIONS
Relative to earnings estimates, emerging & frontier market stocks are cheapest; relative to sales, U.S. Large Cap stocks appear very expensive
BUYBACKS
A record $230 billion of buybacks in Q3; financials and tech were the two leading sectors, repurchasing a combined $125 billion
BUYBACKS & DIVIDENDS
Buyback and dividend yields for U.S. large cap stocks rose in the third quarter as buybacks reached a record high
PRIVATE EQUITY BUYOUTS
Frothy public markets lead to largest IPO year on record
VENTURE CAPITAL
Pent-up pandemic demand has pushed 2021 venture activity to shatter previous records
VENTURE CAPITAL DEAL ACTIVITY
Momentum persists at late stage of venture activity
IPO MARKET
VC-backed tech unicorns were the belle of the IPO-ball in 2021...
IPO MARKET
...until they flopped in the public markets
THE FED PUT
By leaving hikes so late in the cycle, the Fed’s predicament puts them at odds with a 30 year history of being accommodative
FIXED INCOME & CREDIT
What Fisher and other former Fed insiders told me is that the stock market rally was no accident. By design, the Fed’s QE program effectively lowered long-term interest rates, making safer investments like bonds less attractive and riskier assets like stocks more attractive. It was hard to argue with the results: Stock prices kept going up.
– James Jacoby, Financial Commentator, Director, July 2021
MARKET RETURNS SUMMARY
HYBs and bank loans were top performers; International Dev bonds were a major underperformer as “return-free risk” comes home to roost
DURATION EXTENTION
In fixed income, we have been (reluctantly) more tactical over the last two years as a result of the pandemic
TREASURY YIELDS & CREDIT SPREADS
U.S. Treasury yield curve steepened significantly last year while credit spreads remain at or near historically tight levels
SPREADS BY SECTOR
Credit spreads near median across most sectors with limited pockets of opportunity starting to emerge
U.S. CORE BOND RETURNS
2021 was 3rd worst year for U.S. bonds since 1989 and 2022 is off to an even worse start
TREASURY SPREADS
Recent bear flattening, if it continues, could spell the end of this cycle via suggests potential trouble ahead for the Fed and the economy
FIXED INCOME & CREDIT SECURITIES
Treasuries increasingly becoming the largest segment of the now $52 trillion fixed income and credit securities market
GLOBAL RATES
The U.S. bond market remains relatively higher yield, which could help keep U.S. rates somewhat contained
TREASURY MARKET
The treasury market has been an enabler of increasing deficit spending and debt levels... when will it become a “vigilante”?
REAL INTEREST RATES
Powell is right: this time isn’t like the 1970s...from a capital allocation standpoint, it’s worse
PRIVATE DEBT FUNDS
Private debt fundraising bounces back in Q3, but number of funds is on pace for lowest count since 2011
PRIVATE CAPITAL FUNDS
Private debt funds bounced back in Q3, now at more normal allocation levels
REAL ASSETS
We think the energy space is really cheap. What helps is we were not in the energy space before. The amount of capital available in the oil patch is disappearing… [It’s like the] real-estate industry in the early 1990s, where you had empty buildings all over the place, nobody had cash.
– Sam Zell, Equity Group Investments Founder, March 7, 2000
MARKET RETURNS SUMMARY
Real assets sold off in November initially on uncertainty around Covid restrictions and policy, but rallied into the end of the year
REITS
REIT yields may be currently attractive on a relative basis, but in keeping perspective they are at the lowest absolute levels in history
COMMODITIES VS. STOCKS
Commodities have outperformed stocks through the COVID-19 crisis
GOLD MINERS VS. STOCKS
We remain constructive on gold miners
OIL & NATURAL GAS
Oil and natural gas producers have been cautious to bring rigs back online despite rising prices
NATURAL GAS DEMAND
As natural gas inventories started to replenish, prices normalized, but remain elevated
CRUDE OIL DEMAND
Crude oil inventories have been drawn down each week since November, demand for refined oil remains near multi-decade highs
YIELDS
Midstream yields remain substantially above REITs, free cash flow yields of real assets and infrastructure category remain attractive
GOLD MINER FUNDAMENTALS
Gold miner performance has diverged from fundamentals, the industry has seen broad deleveraging and improving cash generation
GOLD VS. NEGATIVE YIELDING DEBT & REAL YIELDS
Real yields rose modestly, and aggregate amount of global negative yielding debt continues to fall
OPPORTUNISTIC
Excesses in one direction will lead to an opposite excess in the other direction.
– Bob Farrell, Former Head of Research, Merrill Lynch
MARKET RETURNS SUMMARY
Closed-end funds and hedged equity outperformed for the quarter; global macro had a disappointing end to a lackluster year
RETAIL MANIA
Retail mania has mostly faded for now
OPPORTUNISTIC BUCKET
Tactical opportunities have been working to mitigate volatility while keeping pace with the broader equity market
OPP MUNI CREDIT
Muni credit sentiment remains elevated, historically associated with lower-than-average forward returns
CRYPTOCURRENCIES
While higher profile digital asset prices have cooled off, interest remains high in underlying themes
Bitcoin ETF launch was another “buy the rumor, sell the news” event
ASSET ALLOCATION
Nobody knows how this is going to turn out. This is an experiment.
– Howard Marks, Co-chairman, Founder Oaktree Capital Management, 2021
STOCKS & BONDS
2021 was an unusual year for global stocks and bonds (and again highlighting the unusual predicament the Fed is in)
CMEs
Expected 10-year returns for domestic equities fell modestly as valuations rose while expected returns for bonds rose with yields
Some good news: longer-term return expectations hold relatively stable as the mean reversion of higher valuations is distributed over a longer time frame
