The year of 2021 was wild, full of surprises and yet a historic one for the markets. Stocks overcame numerous headwinds, including a contested presidential election, an assault of the U.S. Capitol, historically high inflation, supply chain disruptions, the still raging global pandemic and the resurgence in COVID cases due to the new variants. The last quarter of the year started with a continuation of the volatility we saw at the end of the third quarter, as there was little progress in Washington on extending the debt ceiling, avoiding a government shutdown, and providing any clarity on future tax changes. This political uncertainty combined with concerns over corporate earnings after a series of negative pre-announcement sent stocks down in October. However, thanks to the less aggressive messaging on rate hikes from the Federal Reserve and better-than-expected earnings combined with the state governments not imposing crippling lockdowns in response to the surging Omicron outbreak, the markets rebounded strongly and finished the year posting a series of all-time highs, a record that was second only to 1995. For the full year, all four major indexes displayed formidable double-digit returns, with the S&P 500 slightly outperforming the tech-heavy NASDAQ for the first time since 2016, and the Dow Jones Industrial Average marginally lagging both. Large capitalization stocks handedly beat their small-cap counterparts, and the late-year rally helped the growth stocks outperform the value issues. All eleven sectors of our domestic economy finished the year higher. Technology stocks benefitted from the rotation to safety amidst COVID uncertainty, while REITs and financials rose as investors priced in a continued rise in inflation. For 2001, however, energy was by far the best-performing sector in the market as a surge in oil and natural gas prices helped it outperform all other market sectors.
Internationally, foreign markets saw only modest gains in reaction to a stronger dollar while the Omicron variant also weighed on global economic growth estimates.
The fixed income markets, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index, posted a fractionally positive return for the last quarter but declined for the full year, as the possibility of sooner than expected rate hikes combined with high inflation weighed on bonds. Bond yields ended the year higher, with the benchmark 10-year Treasury yield finishing the year at 1.51%, up from 0.91% at the beginning of the year.
U.S. economic growth slowed sharply in the third quarter amid a flare-up in COVID-19 infections, but with activity since picking up, the economy remains on track to record its best performance since 1984.
Americans continued to find employment in 2021. Nonfarm payrolls grew every month during the year, albeit unevenly and sometimes posting disappointing results. Despite the improvement in payrolls, overall employment in the U.S. remains more than three million workers lower than before the pandemic. Viewed from a different angle, currently there are almost 12 million jobs looking for people and only 6.9 million people unemployed.
The causes of the shortage of workers are the subject of much speculation. Has the rise in financial assets created a wealth effect that allowed older workers with savings to choose early retirement? Are ongoing concerns about vaccine efficacy and viral variants giving workers pause when determining whether to return to the front lines? The answer to all these questions is mostly likely, “yes.” And while the most obvious way to fix the imbalance between labor and business is the rise of workers compensation, it may also perpetuate inflation and force the Federal Reserve to accelerate the tapering of quantitative easing and take a more aggressive stand on rate hikes than we currently expect.
At just 21 months old, the bull market that began in March 2020 has already seen a gain of more than 114% in the S&P 500 Index. This means it is already outperformed the 2002 to 2007 rally, which lasted nearly four times as long. After a move like this it might be tempting to assume the trend will simply continue in 2022. But making predictions about the stock market is always a tricky undertaking.
In addition to inflation and monetary policies, markets can be affected by several ominous forces. Efforts to contain COVID-19 can be jeopardized by the rapid spread of yet another variant, which could slow consumer spending to support the next stage of recovery. Geopolitical friction, from potential Russia-Ukraine hostilities to Iran’s nuclear program and tensions between China and Taiwan, could flare up and sour market sentiment. Droughts, fires, floods, typhoons, and other consequences of climate change can drive a dangerous spike in food prices. On the other hand, the aggressive push to decarbonize the economy will lead to underinvestment in fossil fuel capacity before there is a sufficient supply of renewable energy, which will generate much higher energy prices over time. To make matters worse, the near-unprecedented levels of partisan polarization and gridlock in Washington also poses a serious systemic risk.
In other words, caution is warranted as we head into 2022, but not at the expense of optimism. While more subdued economic growth and higher market volatility may be the defining characteristics of the year ahead, so too will the pockets of opportunities that arise in this type of an environment.
Dumont & Blake Investment Advisors, LLC
December 31, 2021