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Market Update - Looking back on 2021...

Updated: May 2, 2022

Happy New Year!

Are you keeping your New Year’s resolutions? Research conducted by Strava (the social network for athletes), found that January 12th is on average the day that most people quit. Hopefully, a few of you are still pushing through!

Here is a list of what the top 10 New Years Resolutions are for 2022:

  1. Lose weight

  2. Eat healthier or change diet

  3. Get fitter and take more exercise

  4. Spend more time with family and friends

  5. Be more aware and take care of mental health

  6. Sort out finances and cut back spending

  7. Travel more

  8. Take up a new hobby, sport or other interest

  9. Be more environmentally friendly

  10. Look for a new job

Looking back on 2021…

Reflecting the genuine economic boom that occurred in 2021, Year two of the global pandemic produced significant divergence across asset classes with equity markets substantially outperforming traditional bonds, which ended the period in the red – a first since 2013 (see chart below).

2021 was nothing more than a slightly better than average year for balanced investors. Naturally, this is mostly a tribute to the sharp rise in equity markets that more than offset bonds’ decline (unlike 2020, when bonds also performed well).

For this January newsletter, we look back at the top 10 key events of 2021 and how they might shape 2022. Happy reading and best wishes for the New Year!

1) It's easy to forget, given the pace at which things are moving, but a key event for the economy in 2021 actually occurred very early in the year. Just weeks after the January 5 runoff election gave the Democrats control of the Senate and barely recovered from the assault on the Capitol, Joe Biden's party passed a third economic stimulus package (American Rescue Plan) worth a hefty US$1.9 trillion. Much like the first two rounds of fiscal relief passed under Trump, this program included cheques of up to $1,400 per person received by about 85% of American households. Yet, the major difference between Biden's plan and Trump's was that incomes (excluding transfer payments) had already largely recovered by the time cheques were sent out, such that total personal income quite literally exploded by March 2021

2) Meanwhile, the vaccination operation was getting underway on a global scale. Recall that initial estimates of the time needed before vaccine distribution could begin ranged from August 2021 as the most optimistic to November 2023 for the most pessimistic. As of July 2021, Canada and the United States had already double-vaccinated roughly half of their population, and we have nearly just reached this threshold worldwide (chart below).

3) Unfortunately, it also became increasingly clear as the year progressed that vaccines were not the silver bullet for which we had all hoped. While places with higher vaccine coverage (such as Canada) weathered the Delta wave relatively well, the arrival of the Omicron variant in December brought new highs in cases. Yet, thankfully, only a marginal rise in fatalities (chart below).

4) Thus, with demand for consumer goods bolstered by generous fiscal measures on the one hand, and a pandemic that has continued to complicate the day-to-day operations of many ports and factories on the other, supply chain issues have proliferated like never before in 2021. Microprocessor shortages, soaring shipping costs, rising energy prices are all trends that, although they have stabilized for the most part recently, are likely to linger for a few more months, especially if the pandemic keeps getting worse, notably in Asia.

5) Ultimate consequence of these imbalances? Multidecade highs for inflation in many countries such as Canada, but especially in the United States where the Consumer Price Index (CPI) is up 6.8% on a year-over-year basis—a 39-year record. Yet, this toll is driven largely by the rise in durable goods prices, which, after spending most of the past 20 years in deflation, have over the past 12 months surpassed even the highs set in the late 1970s (chat below). It’s hard, in light of such figures, to deny the circumstantial nature (at least in part) of the inflationary dynamics that have dominated the headlines in 2021.

6) Many, if not all, had expected inflationary pressures to develop, but certainly not by this magnitude. As of December 31, the outlook for inflation remained relatively high, although it had moderated and mostly concerns the next five years, with the longer-term expectations still anchored near historical norms (chart below).

7) A key factor likely to contribute to higher inflation figures in the medium term is, unequivocally, the scarcity of labour. This challenge was in play before the pandemic, and demographic trends indicate that it will remain with us for many years to come. That being said, there is little doubt it has been exacerbated by the pandemic situation – never before have so many companies indicated difficulty in finding workers. This has already started to put upward pressure on wages – closely linked to services inflation – and is likely to continue in the coming months (chart below).

8) For the Federal Reserve, this backdrop has resulted in a historic pivot. Faced with stronger and more persistent inflation than expected, the U.S. Central Bank, that had self-described its approach as “wait-and-see” at the beginning of the year, has gradually adjusted its rate-hike projections: starting from zero, and now projecting three rate hikes in 2022, two in 2023 and two in 2024 (chart below).

9) In the bond markets, short-term rates rose more sharply than longer-term rates. This 2021 highlight suggests that, despite the strong growth and inflation of the last few months, markets remain far from convinced the Federal Reserve will be able to raise interest rates beyond the normalization process it intends over the next 2 to 3 years without ultimately triggering a recession.

10) As for stock markets, there are many highlights, but one particularly interesting aspect is the source of returns. Recall that in 2020, nearly all equity gains were achieved on the back of expanding price-to-earnings ratios (PE ratios). That is to say, stocks got more expensive without any growth in profit. This led to an arguably overvalued market. In 2021, the exact opposite occurred (chart below), with the sharp recovery in earnings more than offsetting the decline in valuations everywhere except in emerging markets. This serves as a reminder that a market can be either expensive or cheap for the right reasons.

To be clear, this does not mean that valuation measures should be completely ignored under any conditions. In this regard, our annual review would not be complete without mentioning the powerful horde-effect of a growing community of speculators who have snapped up stocks whose value generally lies in their ability to generate fun memes (e.g. Gamestop, AMC), their promise to transform the monetary system (e.g. Bitcoin, Ethereum) and, occasionally, both (e.g. Dogecoin, which requires a scale of its own) (chart below). It's hard not to see symptoms of a bubble for these market segments which have certainly benefitted from an environment of zero rates, abundant liquidity, and a mass of confined investors seeking entertainment. Time will tell how this growing phenomenon will evolve in what should be less fertile ground for such assets over the coming years, in principle. To be continued!

As always, please contact any of our team members to discuss the impact 2021 had on your portfolio or how we are preparing for 2022.

- Your Creed Capital Management Team

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