“My company keeps nagging me to sign up for the company 401k, but honest to God, I don’t think I can run that far.”
― Norm MacDonald
A constant theme of this market commentary is that predicting the future is hard (if not impossible) and that when it comes to something as important as your financial future, relying on prognostications, which probably end up wrong, is a fool’s errand. The last year, and the fourth quarter in particular, provide an example that even if you knew some of the facts ahead of time, using them to predict stock market performance is not an easy task. In fact, ‘knowing’ the facts beforehand would probably make the task even more difficult, as those pesky facts would just result in an overconfident market forecast.
We began 2021 with benign levels of inflation, low interest rates, and the promise of the beginning of the end to the COVID-19 pandemic with the rollout of the Pfizer, Moderna, and J&J vaccines. By the end of the year all of that had changed. The year started with an inflation rate of 1.4% (December 2020 CPI) and the 10-year Treasury bond priced at a yield of 0.93%. By year’s end inflation had risen to 6.8% (the highest level of inflation since the 7.1% reported in June of 1982) and the 10-year Treasury was yielding 1.52%. The severity of the summer/fall surge in COVID-19 cases due to the Delta variant was mitigated, in large part, due to the vaccine rollout, but year-end brought us the Omicron variant and a surge in infections that threatened significant negative travel and economic impacts, at least over the short term.
Given those facts – the highest level of inflation in 39 years, rising interest rates, and a resurgent pandemic, it would be natural to assume that equity markets might struggle. Throw in persistent supply chain problems and continued gridlock in Washington and it would seem that 2021 was an environment somewhat hostile to stock market performance. But such was not the case. The S&P 500 returned 28.70% in 2021, and 11.03% in the fourth quarter, despite the raft of economic challenges. Small-cap stocks (Russell 2000) rose a lower, but still impressive, 14.82% for the year and foreign markets (MSCI-EAFE) gained 11.26%. Given the exogenous economic shocks of 2021, the performance of equity markets was quite remarkable.
Bond markets, however, didn’t fare quite as well. Rising interest rates presented a persistent headwind for bond returns. The Bloomberg US Aggregate Bond Index eked out the slimmest of positive returns in the fourth quarter, up 0.01%, and ended up down -1.54% for the year. Municipal bonds, driven by favorable supply/demand dynamics, were up 0.21% in the fourth quarter and a paltry 0.36% for the year.
Looking forward (which as noted above is a perilous endeavor), the Federal Reserve indicated in their December 15 FOMC statement that it would accelerate the reduction of its monthly bond purchases. Additionally, 12 members of the 18 member FOMC expect at least three interest rate raises in 2022. In a world with tightening monetary policy and rising interest rates, we should expect continued challenges for bond returns. And at some point, rising rates will begin to attract capital to bonds at the expense of investing in riskier assets. But as we’ve seen, even if you know the environment (which we don’t), stock market returns are still virtually impossible to accurately forecast. And that’s why having a well thought out investment plan that accounts for your personal situation and the unpredictability of financial markets is crucial to long-term financial success. Because, as we’ve seen, even if you know (or think you know), you never really know.
As always, please let us know if you would like to discuss your portfolio or current market conditions in greater depth.