- 2021 was a strong year for risk assets as the S&P500 gained almost 29%.
- Higher than expected inflation has pushed to Fed to taper its asset purchases and will likely cause interest rate hikes in 2022.
- International stocks continue to lag the US markets, but long-term investors have benefited over time from global diversification.
2021 marked a solid year for risk assets as the global economy recovered from the shutdowns of 2020. Despite new coronavirus strains during the summer and fall, US stocks pushed to new all-time highs during the year. The S&P500 closed 2021 up 28.71%, it’s third largest calendar year gain since the turn of the century. Low interest rates coupled with strong economic growth fueled not only equity prices higher, but prices for goods and services for consumers. Inflation, which had been rather subdued over the past decade, came in at readings not seen since the early 1990s. The Federal Reserve has responded by beginning to taper their asset purchases of Treasuries and mortgage-backed securities, which were meant to provide liquidity during the crisis. In addition, the Fed will likely begin raising interest rates in 2022 to keep inflation under control. Against this backdrop, many economists and market participants expect economic growth to moderate in 2022, which may cause equities to have a more muted year.
International stocks lagged the U.S. for the fourth consecutive year. In efforts to combat coronavirus outbreaks, lockdowns in Europe and Asia slowed economic activity during the year. The MSCI EAFE Index, which is a measure of international developed countries, managed to gain 11.26% in 2021. Emerging market stocks dropped 2.54% with losses in Chinese, Latin American and Korean equities. Economic disruptions across the globe caused supply chain bottlenecks, further exacerbating global inflation. While international investments have struggled against their US counterparts over the past few years, their attractive valuations and long-term diversification benefits should not be ignored.
Bonds were a challenging asset class as Treasury yields climbed during the year. The Bloomberg US Aggregate Bond index lost 1.54% in 2021, its second worst annual return since 2000. Inflation protected securities (+5.96%) and high yield (+5.00%) were the best performing sectors following strong economic growth and higher inflation, while intermediate Treasuries lost 2.87%. If the US economy continues to grow and inflation remains elevated in 2022, yields will likely climb. While that may not create positive returns for bonds this coming year (bond prices fall when yields rise), it is important to remember the role of bonds in a diversified portfolio. Looking back to 1990, the Bloomberg US Aggregate Bond Index was positive in every calendar year that the S&P500 was negative. It is also important to remember that as interest rates climb, so do yields. Bonds maturing may be re-invested at higher yields so there will likely be some short-term pain to achieve a longer-term gain (higher yields).
Sources: Morningstar Direct, Wall Street Journal, Nuveen, Capital Group