AS we approach year-end and face a second consecutive Christmas in which the pandemic continues to surprise scientists, politicians and investors alike, we continue to live with uncertainty.
Before we tune the crystal ball to 2022, let’s focus on the winners and losers in capital markets over the last 12 months, to see which investments have made the ‘nice’ list this Christmas.
Global demand continued to recover remarkably quickly for much of 2021, spurred on by governments and consumer demand. However, as we now know all too well, meeting that supercharged demand with adequate supply, from microchips to natural gas, has proved challenging. As a result, prices have increased and we have seen a sharp rise in inflation, which has proven to be stickier than initially forecast.
From an investment perspective, the winner in this scenario has been the commodities market, which has surged this year as businesses have had to pay more for their fuel and raw materials (which has not been so good for consumers unfortunately).
Despite rising inflation, up until now central banks remained reluctant to tighten monetary policy and raise interest rates, still cautious about the strength of the economy in light of the pandemic. Importantly, the real (inflation adjusted) cost of borrowing continued to sink as a result. Bond values were particularly impacted as their already-low yields have been eroded, consigning this asset class to a year of relatively poor performance.
The other notable casualty this year has been cash, for which it remains all but impossible to achieve a real return after adjusting for inflation, with the reality being that cash savings have in fact lost purchasing power over the course of the year. However, the instantly accessible, highly liquid nature of cash means that it remains a crucial asset class despite the obvious drawbacks.
While cash and bonds stuttered, another winner this year has been the stock market. Company profits have soared as the global economy continued to recover at pace from the initial, significant jolt caused by the pandemic in 2020. Coupled with the low cost of borrowing, this led to higher share prices and returns – indeed, the S&P 500 index, which is considered the leading indicator of US stock performance, has set more than 50 all-time highs this year alone.
Concerns about a stock market bubble seem as closely associated with all-time highs in stock markets as Christmas is with Santa Claus, however there may be a bit more substance this time. Valuations in parts of the world’s stock markets, particularly those areas that fall under the broad banner of ‘growth’, have begun to look increasingly frothy during 2021. This is at least partially offset by what we would see as excessive gloom in other, less ‘hip’ sectors of the market.
When reflecting on this year’s winners and losers, regular readers will know that we always suggest taking a long-term diversified approach and our frequently restated investment mantra that past performance is not a reliable indicator of future performance.
It is important not to allow your investments to become too centred on a basket of recent winners. The reality is that next year’s winners could look quite different to those of 2021, as there are too many unknowns on the horizon to know for sure what the capital markets hold in store.
It’s worth remembering that Santa Claus is a wise and forgiving character who’s willing to turn a blind eye to the odd bit of bad behaviour. The big man knows the disappointment of receiving the dreaded ‘bag of coal’ is a much less favourable outcome than the joy and excitement of a child unwrapping that special gift they have been hoping for.
Similarly, as investors, we should be prepared to tolerate and accept periods of under-performance (naughtiness) across asset classes; the very nature of diversification dictates that not everything will be on its “best behaviour” at all times.
And because we never know which part of our portfolio will drive positive returns in the future, we should be very wary of consigning a holding to the ‘naughty’ list without careful consideration.
:: Mark Rooney is a wealth manager at Barclays Wealth and Investment Management team in Belfast.
