Market Navigator – January 2022 edition

Monthly letter

The stock market powered higher in the final month of the year to cap off a stellar 2021, despite ending a second year with COVID-19 as the dominant headline. Indeed, if given the news headlines for the year ahead of time, which included the delta variant and omicron surges as well as multi-decade high inflation readings, it would have been hard for investors to predict such robust gains.

However, each subsequent COVID-19 surge had a lower economic and market impact. Medical care has vastly improved, and unlike when the pandemic originally hit, businesses and consumers have adapted and have a playbook from which to pull during flare ups.

Even in the midst of challenges, the global and U.S. economies grew at their fastest rates in decades. U.S. job gains rebounded at a record annual pace, and corporate profits, a key underpinning of our bullish outlook over the past two years, simply blew away expectations. While the global financial markets had a strong year overall, it was also one of wide divergences among asset classes.

Fortunately, our investment process led us to take advantage of many of these key market divergences.

Global stocks outperformed bonds by almost 20% during the year, benefitting our overweight to equities.

U.S. stocks beat the international markets by the second largest amount in the past 10 years, bolstering our long-standing domestic bias.

High yield bonds, which we favored, outperformed core bonds by the most since 2016.

That’s not to say all of our calls panned out. For example, our value style tilt lagged. But overall, our guidance benefitted portfolios in 2021.

As we look forward, our team anticipates another solid year for the economy and capital markets, but we also expect some of the aforementioned asset class divergences to narrow.

• Our macro team expects well-above-trend global economic growth but a notch lower than 2021.
• We remain positive yet realistic that, after the robust stock gains of recent years and with less policy support, returns should moderate and we expect more normal pullbacks.
• We maintain our U.S. equity bias given its blue chip status. We expect the margin of outperformance, though, to lessen as international developed markets enter 2022 oversold.
• We retain a negative view of emerging markets given ongoing challenges in China and weak earnings trends.
• Within the U.S., we see an opportunity in small caps, given attractive valuations and strong fundamentals.
• We stay neutral the value/growth styles given an ongoing tug-of-war between above-trend economic growth versus COVID-19 flare ups and tighter monetary policy.
• Entering the year, we favor a barbell approach of cyclicals and growth sectors, with an overweight to energy, financials, real estate, and technology.
• Our fixed income team expects higher rates and higher volatility to create another challenging year for core bonds. In 2021, the core U.S. bond market saw only its fourth annual decline since the late 1970s. Still, the mild annual decline of 1.5% shows a bad year in bonds has historically only been the equivalent of a bad day in the stock market.
• Within fixed income, we still see a relative opportunity in credit, particularly in leveraged loans, which historically have tended to provide some inflation protection and outperformance during rate hike cycles.

Importantly, this is our starting point. As the past few years remind us, it’ll be essential to be flexible and adapt as the data shifts and to approach markets with a fair degree of humility.