The start of a new year offers a good opportunity to pause, take a step back from the daily market gyrations, and reflect. While 2021 certainly had a lot of twists and turns ranging from a pandemic that won’t go away, to inflation, to meme stocks, it ended up being a rather pleasant year for investors with many equity indices advancing over 20%. We will save a deeper dive into market performance for another time, but for now let’s hit a few of the highlights of 2021.
As 2021 started, the race to develop, gain approval, and rollout vaccines was really starting to get going. Thanks to a global effort by governments, healthcare companies and advances in science, vaccines that historically have taken a decade to develop were completed in less than a year. Mass production has resulted in over 9 billion jabs administered in 2021. Truly impressive.
Now if you had told anyone a year ago that 9 billion vaccines would be distributed, most would have expected the daily case counts to be lower today. But the Omicron variant, combined with much broader testing, are now driving new records for cases. So far, the evidence supports that vaccines limit the spread and, even more importantly, dramatically reduce hospitalization rates. Nonetheless, the world thought we would be in a better place by now. This pandemic has truly proven to be more persistent, with some starting to use the word ‘endemic.’
Society has adapted and continues to learn how to live with the virus. While approaches vary considerably from region to region, it is testament of people’s resilience and adaptability.
Very often the phrase ‘new normal’ is bantered about in an attempt to describe what life will be like after the pandemic fades. However, the pandemic may be more akin to hitting the fast-forward button on a number of pre-existing trends like remote work, diminishing bricks & mortar retail, the cloud, and AI… the list goes on. 2021 saw a dramatic increase in the speed of these trends, in many cases out of necessity.
The digital domination drove demand for hardware, connectivity, nicer home office chairs, and of course improved backgrounds for those abundant Zoom calls. Conferences, education, and meetings all moved to a virtual world. Documents are now signed digitally and shopping went more and more online.
While there were many losers (i.e., companies that suffered from the acceleration of many key trends), there were some big winners too. The good news for the equity markets is that the winners tended to have a much bigger weight compared with the losers—an advantage to market-cap-weighted indices.
Supply Chains & Inflation
Netflix was able to meet the rising demand of changing consumer habits caused by the pandemic—the more subscribers, the merrier. The same cannot be said for producers of goods. As spending habits changed, from dinner out to home improvements, supply chains simply couldn’t adjust quickly enough. Adding to the complexity of supply chain logistics were pockets of disruptions caused by Covid outbreaks.
The interconnectivity and dependence of supply chains became very apparent. Although grossly simplifying, a good example of this is how less wind in Europe led to more gas demand as weather cooled; supply was slow to respond, which resulted in fertilizer production being taken offline and drove potash prices higher globally, which in turn increased agriculture prices. Yes, your Cheerios may cost more because of calm winds in Europe.
Changing spending habits, bottlenecks, disruptions, and high energy prices have driven consumer prices higher. While this will ease as the supply side re-adjusts to meet demand, and consumer price index (CPI) data will come back down, the question is whether the longer-term seeds of inflation are planted and starting to grow? We believe periods of elevated inflation are likely to be a recurring theme in the years ahead but will be likely much lower than CPI data is printing today.
Weather deserves mention in any look back on 2021. With wildfires, floods, heat domes, atmospheric rivers, one would have to assume a polar vortex is next. There is no denying sustainability gained a lot of attention and traction in 2021, highlighted even more by the COP26 gathering.
This has led to increased focus on sustainability, including from the investment world. Key funds have increasingly announced the desire to stop investing in fossil-fuel-related companies. Meanwhile most companies continue to improve their respective carbon footprints, even companies in the extraction world.
2021 may go down as the ‘great resignation’ year [present company included]. On the surface one would assume with many people working remotely, switching employers would be a more challenging endeavor. It is not easy to make new friends and connections via Zoom as compared with sitting in the office, within the corporate ether. Still, lifestyle choices, increased demand for labour, inflated stock & home prices, and perhaps even just working from home pondering “what’ s next,” has led to record paces of quitting.
It may actually be more labour freedom from geography. While anecdotal, in a conversation with an advisor team in our Partnership Program, they highlighted that 2021 saw a much higher proportion of new clients from cities outside their home turf. Geography isn’t the barrier it used to be as meetings are now virtual and documents are signed digitally. In a very cool chart from McKinsey & Company, in a survey of people who started a new job in a different city, only 13% were required to move to the new city.
2021 appears to be a year that labour enjoyed more flexibility and negotiating power, which led to substantial changes in how, where, and when people are working.
So How About Those Markets?
2021 will likely be remembered as one of those years where investors made a healthy return, let’s say 8-12%, yet feel like it should have been more. The pain of the bear market of Q1 2020 appears to have left most investors memory and has been replaced by the barrage of headlines highlighting record highs for the S&P 500 and the Toronto Stock Exchange (TSX). The S&P 500 made a brand new all-time high in 14 consecutive months, rising 28.7% in 2021. TSX doesn’t have the same string of records, but +25.1% for any calendar year is impressive.
There is no denying that the TSX and S&P 500 had great years. The news keeps getting better as it wasn’t just the mega caps. Microsoft, Apple. Shopify, and Royal Bank, given their weights and solid performance, did some heavy index lifting. But the gains were broad based with the median index member returns relatively close to the overall market. This can also be seen in the roughly equal performance of the S&P 500 and S&P 500 equal weight index. Plus, very few companies lost money. Only about 14% of the S&P 500 members declined on the year, while 26% of TSX members fell (skewed a bit higher by more gold and marijuana companies, which comprised about ½ of all the companies that declined).
Geographic Equity Diversification Hurt Performance in 2021
If you only owned Canadian and U.S. equities, you are likely feeling especially good about 2021. However, most of us have diversified portfolios because sadly not all years are like 2021. That being said, diversification, either by geography or by asset class, detracted from performance this past year.
Other major equity indices did not keep pace with North American markets, especially once converted back into Canadian dollars. Europe did ok at a bit over 10%, while Asia did much worse, and emerging markets were all over the place. Still, equity returns were largely positive and, in many cases, positive in a material fashion.
You know what grew even faster than equity markets in 2021? Earnings. Companies pivoted and adjusted very quickly to pandemic-induced changes in behaviour. Combined with unprecedented monetary and fiscal stimulus, driving the global economy first to recover then to start reaching new highs, earnings growth spiked higher. Even when ‘P’ rises, if ‘E’ rises faster, you get better valuations. This was the case in most equity markets.
Asset Allocation Diversification Muted Returns
Outside of equities, returns were even harder to come by. With global yields rising during the year, bonds had a tougher go, and in most cases, lost value during the year. Truth be told, these results would have been worse had Omicron not surfaced to push global yields back down. Credit performed well, although this performance was front-end loaded as the economy gained traction and fear of bankruptcies faded.
Put It All Together
2021 was a very eventful year, lots of news, great economic growth, and thankfully markets that reacted well. A generalized balanced portfolio likely came through the year ranging between 8-12%, depending on investment mixes. Yes, the defensive positions probably dragged down performance, but that is literally what they are designed to do—act as a ballast for the overall portfolio in good times, not just bad times. Overall, it’s hard to complain about 2021 from a portfolio perspective.
Human nature may have investors desiring to tilt portfolios to take on more risk. While we do remain bullish for 2022 (see our “Purpose 2022 Outlook: The long road back to the new normal” for more insight), it would appear some of the future performance may have already been enjoyed by the markets. Overall, this year will likely prove more challenging given central bank pivots, continued inflation issues, and the slowing pace of growth. We suggest that it may prove inopportune to expel defensive components of your portfolio and chase upside as we head into the new year.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
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Sources: Charts are sourced to Bloomberg L.P.
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