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Markets, investing and what matters most: Quarter in review Q4, 2021

By ATB Wealth 21 January 2022 9 min read

Written by Ralph Jaglal, CFP, CFA and Daniel Spencer, CFP, CFA on behalf of Private Investment Counsel, which believes in a holistic investment counselling approach to helping high-net-worth clients.

Following the volatility and uncertainty of 2020, 2021 unfolded with a broad theme of economic growth and stability, largely tied to the development and widespread deployment of multiple vaccines. Despite the rise of new variants, consumer demand was not permanently damaged from the shutdowns and lockdowns of 2020 as we witnessed a consumer-led recovery in 2021. On the other hand, we saw the rise of inflationary pressures driven in many cases by higher energy prices and supply chain constraints and disruptions. These two events are of course connected.

Equity and labour markets fared well in 2021, though fixed-income markets struggled as inflation became a hotly debated topic with a number of central banks signalling a quicker transition from accommodative to neutral interest rate policies. As we rounded out 2021, the final quarter brought good equity market performance in October, weakness in November and a strong December culminating in a traditional ‘Santa Claus rally.’ Notably, equity performance was largely attributed to a meaningful earnings recovery while price-earnings multiples actually contracted.

Some key highlights of the past quarter include:

Economics

  • The Canadian unemployment rate stood at 5.9% in December, slightly above its pre-pandemic level of 5.7% in February 2020. Alberta’s unemployment rate ended the year at 7.3%, down 3.8% from a year ago.
  • The US unemployment rate declined to 3.9% in December, slightly above its pre-pandemic level of 3.5% in February 2020. Employment continued its trend up in leisure and hospitality, professional and business services, manufacturing, construction, transportation and warehousing — all pointing to a sustained recovery in the job market driven by a fast-recovering economy.
  • We continue to wait on fourth quarter results, however, we saw Canadian GDP rebound 5.4% in the third quarter, compared to the 3.2% contraction in Q2 resulting in annualized growth of 4.0%.  

*Canadian Data from Statistics Canada, US data from Bureau of Labor Statistics

Markets

  • The final quarter saw positive returns from all major asset classes, with notably strong performance from the major equity markets. While fixed income was positive for the quarter, bonds were down roughly 2.5% for the year making 2021 the worst year for bonds since 1994.
  • Equity markets enjoyed solid growth in October, were sold off in late November with the emergence of the Omicron variant, and then recovered in December to close the year at or near new highs. The S&P 500 finished the quarter up 10.88% while the S&P/TSX was up 6.47%, and the developed international markets (measured by the MSCI EAFE) up 2.56%, all in Canadian dollar terms.
  • The yield on 10-year government bonds (Canada) sat at 1.43% at the end of the year, a significant increase from the 0.68% they were at one year ago. While government bond yields in both Canada and the US have risen compared to last year, they remain low in historical terms. Our active fixed-income holdings remain focused on shorter duration and higher-yielding corporate bonds, a strategy that fared especially well as our fixed-income allocation ended the year positive 2.93%1 despite the negative 2.54% for the FTSE Canada Bond Universe Index.

*Return data from Bloomberg unless otherwise noted

Chart of the quarter and a word about volatility and recency bias

We regularly remind clients that for every year in which positive returns were realized, there was some point during the year where markets and portfolios were in negative territory. These intra-year declines for the CompassTM Portfolios are illustrated in the chart below. These drawdowns happen at some point each and every year, and the higher the long-term expected return of a portfolio (i.e. portfolios with higher equity weightings), the larger those drawdowns tend to be. It’s always important to remember that volatility is the price we pay for higher returns in the long run.  

The chart below shows the calendar year returns and intra-year declines for our most conservative and most aggressive Compass Portfolios. Noteworthy are the muted levels of intra-year declines in 2021 compared not only to 2020 but to their historical averages as well. For the Conservative Portfolio, the average intra-year decline was -3.10% (compared to -1.7% in 2021) and for the Maximum Growth Portfolio, the average intra-year decline was -11.86% (compared to -4.9% in 2021). 

Recency (or availability) bias is a recognized and well-studied area in behavioural economics that describes a cognitive information-processing bias that can lead to faulty reasoning and analysis. In a nutshell, this is a bias where people have a tendency to believe that recent events will happen again. Unfortunately, this is an irrational tendency as it ignores the objective probabilities of events occurring and hence can lead to poor decision making. It’s a relevant bias to be aware of in our current environment where we are seeing a pick-up in volatility at the start of 2022, which is normal, whereas 2021 was an unusual year for its low levels of volatility. Of course, we all would love a market environment low in volatility and high in returns all of the time, but that’s not realistic. It’s important not to let our wants skew our thinking and decision making at the cost of achieving our long-term objectives.

Calendar year returns vs. intra-year declines, 2016 to 2021

Source: ATBIM


Portfolio performance and positioning

During the quarter, all of our portfolio strategies — the Compass Portfolios and ATBIS Pools Series O — enjoyed positive returns, with equity-weighted portfolios outperforming more conservative portfolios. While our general underweighting to technology stocks led to some lag in our equity performance in 2021, this positioning is bearing fruit as markets begin 2022 with a rotation into value oriented sectors. This tracks well with our view of a rising-interest-rate environment, which is generally more favourable to value-oriented securities.

Compass Portfolios & ATBIS Pools returns, series O
Q4, 2021

Source: ATBIM


Aside from a slight change to our equity allocation moving targets higher by 2%, there were no major changes initiated by the Portfolio Management team within the Compass Portfolios in the fourth quarter. This increase in equity allocation led to a corresponding reduction in our fixed-income allocation (note: this change does not impact our Compass Maximum Growth Portfolio as it is already 100% equity). Within our active fixed-income strategies, credit quality steadily improved throughout the year, and duration was reduced by almost a year in anticipation of the rising interest-rate environment we now find ourselves in.

 

Inflation: When good news is also bad news

Unless you live without TV, radio or the internet, you’ve heard the word ‘inflation’ mentioned with increasing frequency in the last few months. In October, we released a detailed overview of this topic. Since October, inflation has taken on larger prominence in the media, including the news last week that US CPI reached 7%, its highest since 1982.  

The good news is that prices are higher simply because aggregate demand has risen more quickly than supply. Strong demand speaks to a financially healthy consumer, and consumers account for approximately 70% of economic activity in developed countries. Coming out of the challenges of 2020, this is what we want to see. The bad news is that all the challenges of 2020 and into 2021 negatively impacted global supply chains (i.e. limiting supply) and when coupled with tight labour markets and higher demand for goods and services, an inflationary spike does not come as a surprise. 

For much of 2021, the consensus among central banks was that this period of higher inflation would be ‘transitory.’ In other words, higher inflation levels were expected to dissipate into 2022 as imbalances between supply and demand moved back into equilibrium. Indeed, much of the inflationary pressure has arisen from commodities (especially energy) and durable goods — two sectors that tend to decrease in price over the long term. For an interesting and easy-to-read illustration of the inflation situation in the US, read this article

The chart below also shows the year-over-year change in the headline and core US Consumer Price Index (CPI) to December 31, 2021. We can see the impact that energy and goods have had on headline inflation.

US CPI YoY% NSA including topline contributions & Core CPI

Source: Bloomberg, BLS


As the fourth quarter unfolded, the consensus among central banks began to adjust to the growing likelihood of inflationary pressures being more sticky and less transitory than originally thought. Significant contributors to this inflationary ‘stickiness’ remains elevated by energy prices and supply chain constraints, exacerbated in large part by China’s policy focus on zero COVID-19 transmissions, resulting in ongoing and unpredictable foreign trade interruptions. 

The Bank of England made the first move when it raised interest rates by 15 basis points in December. US Federal Reserve Chair Jerome Powell announced in December that it would immediately begin tapering its monthly asset purchases (treasuries and agency bonds) by $30 billion per month and would likely begin increasing interest rates in the new year. This represents a doubling of their previously announced schedule and will result in the Fed ending its purchases by March 2022. As a reminder, the US Fed had begun its program of asset purchases in 2008 (under then-Federal Reserve Chair Ben Bernanke) in response to the well-known financial crisis that began that year. 

For perspective, a couple of things are worth remembering. First, for over three decades, central banks in the developed world tended to undershoot their inflation targets. Following the financial crisis in 2008, there were numerous times where fears arose about disinflation and even the much worse monster of deflation. So here we are on the back end of a highly disruptive global pandemic with consumer demand intact, strong economic growth, low unemployment and, of course, inflation. Of all the possible scenarios, this is far from the worst case.

Regardless of what happens with inflation, we believe the Compass and ATBIS Pool funds are well-positioned to perform better on a relative basis. Our active equity managers target cash flow producing companies with competitive moats that can pass along price increases. These types of companies have performed well through historical periods of inflation.

On fixed income, we are invested in securities with shorter durations, which are less sensitive to changes in interest rates and can take advantage of rising yields more efficiently. Our tilt towards credit results in higher yields versus government bonds, which can mitigate the impact of falling prices due to rising rates.

 

2022, a new year with new risks and opportunities

Central banks will move towards neutral interest-rate policies from their long standing accommodative stance. This will ‘feel’ new, but it will be a far cry from an aggressive tightening cycle. While rate increases typically moderate growth, household savings remain high and consumer demand should support earnings growth in equities for years to come. 

Equity valuations moderated through the year. For example, the S&P/TSX price earnings ratio declined from 26.8 at the end of 2020 to 19.58 at the end of 2021. This gives an earnings yield of 5%, which, when coupled with real earning growth of 1 to 2%, can still present a forecasted return of 6 to 7% for stocks over the medium to long term. In short, we continue to believe equities remain a good value when compared to other assets such as bonds with yields of around 2%.  

 

Finally, goodbye to an old friend: RIP BlackBerry

Younger readers may not recognize the significance of this, but there was a time when BlackBerry ruled the roost when it came to mobile security. From the original pager to the indestructible ‘brick’ with a keyboard and side scroll wheel, to arguably the all-time favourite BlackBerry Pearl (with its totally awesome trackball), having a BlackBerry was the hippest device to own for business and personal use. During the last quarter, the era of BlackBerry officially came to an end. Find out why in this Financial Post article.

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