2021 was remarkable. Despite a number of headwinds equity market soared, as did returns within the Tactical Allocation Portfolio (TAP) and its various risk-adjusted sub-models. Below we will outline a number of those headwinds in addition to tailwinds both past and present. It is worth noting we remain bullish on equities, at least for now, if you’ve read and digested our content in the past you know that we do our best not to prognosticate as to what lies ahead.
First and foremost, easy monetary policy coupled with historic amounts of government stimulus carried over from 2020 into 2021 and not only served as a means to subvert financial crisis due to COVID-19 but also as a crutch to bolster economies globally. Equity markets benefited as not only did consumers (and businesses) reduce liabilities and increase cash savings but also deployed excess cash into equity markets and other investment assets, dividends and stock buybacks creating demand. We have talked about consumer spending and it’s almost 70th percentile allocation to GDP in our country. 2021 witnessed yet again robust activity in this space. Whether pent up demand, above average savings, a healthy labor market or a host of other reasons the consumer in the US delivered last year. A trend that will likely continue as a meaningful tailwind but one that has already begun to moderate.
Before moving on we must revisit easy monetary policy and government stimulus as what is carrying over into 2022 is not as favorable as what we saw last year. Central banks around the world, including our own, are quickly changing course to battle the highest readings of inflation in a generation (since 1982 to be precise). The Federal Reserve has already begun tapering asset purchases and one if not several interest rate hikes are anticipated this calendar year. Both of these measures will of course increase the cost of capital to both consumers and businesses. Businesses have seemingly been able to pass on increased costs to consumers thus far but there is risk in the consumer balking at a continued rise in the cost of goods and services. In our opinion inflation is the most meaningful headwind markets face in 2022 despite the fact that equities have behaved well in inflationary environments historically speaking.
Additional headwinds include over valued assets and of course continued resurgence of COVID-19 variants. Without going into too much detail, the S&P 500 had a PE Ratio as of December 31, 2021 of almost twice its historic mean. As you know we are technical and not fundamental analysts so don’t put too much weight on this metric, but 2x its historic average is worth mentioning. If you have tried to buy a home, investment property or just about any other asset over the last year you have witnessed similar ‘valuations’.
Only time will tell what COVID-19 has in store but we feel the worst of it, think lockdowns and mass quarantine, is likely behind us. The technological advancement of vaccines, boosters and therapeutic pharmaceuticals is encouraging at very least. Despite the Omicron variant wreaking havoc, at least in the communities we live in, some sense of normalcy, or turning the corner from pandemic to endemic seems to be getting closer every day. As it does we anticipate so will economic activity.
As stated above TAP had one if its best years since we started developing the approach over a decade ago. The equity model reduced risk at appropriate times, for the most part capturing profit on positions that were purchased in the spring of 2020 coming out of the early days of the pandemic. Technology, biotechnology and healthcare, whether in the form of Exchange Traded Funds (ETFs) or individual stock selection, paved the way for above average returns. Rotating out of several of these higher beta sectors of the market also allowed us to reposition the model’s overall risk profile to more moderate over the course of Q4 in particular.
The fixed-income model remained true to the intermediate portion of the yield curve for almost the entire calendar year. Albeit a recent rise in interest rates as measured by the CBOE 10 Year Treasury Yield Index has put that strategy in question over the last several weeks.
We more than appreciate the continued commitment from those who have chosen to work with our firm and look forward to connecting with you as we embark on a new year. And wish everyone reading this a happy, healthy and prosperous 2022. And finally, a special note to clients, family and friends of the firm in Colorado affected by recent wildfires. Our thoughts are with you and your families.
Fraser, Dudley, Alex, Josh, Christie & Melanie