In the fourth quarter, developed market equities continued to rally, providing investors with the third calendar year in a row of strong positive returns. Strong earnings growth drove equities higher. Fixed income performance over the quarter was flattish, as markets had to digest rising inflation and less easy policy from central banks.
The emergence of the highly infectious Omicron variant led to a spike in equity market volatility at the end of November, but markets quickly recovered as data from South Africa and the UK indicated a lower risk of severe disease. Current corporate strength and the prospect of further potential earnings growth in 2022 outweighed the risk factors over the quarter, despite the fact that hospitalizations rose towards the end of the year in several countries.
But the fear of a weaker future growth backdrop, partly due to projected central bank policy normalization, led to a flattening of the US yield curve. Small caps also underperformed large caps over the quarter as uncertainties about future growth weighed on their performance.
In the US, President Biden signed the Infrastructure Investment and Jobs Act, a long awaited $1.2 trillion bipartisan infrastructure bill. The bill includes $550 billion of additional spending, 49% of which will be allocated to upgrading America’s transportation sector, including ports, airports, railroads, roads, bridges, and public transport, and 32% will be used to improve water and power infrastructure. The remainder will be spent on broadband (12%) and the environment (7%). The ambitious Build Back Better spending bill ($1.7 trillion) didn’t muster a majority in the Senate in December. However, private sector fundamentals look solid enough to carry US growth next year. Strong performance of financial assets and real estate have pushed the ratio of US household liabilities to assets to its lowest reading since 1973. This, along with still elevated savings, gives the consumer significant firepower in the coming years.
In November, the US Consumer Price Index (CPI) jumped to 6.8% year-over-year, its highest reading in 39 years, and the unemployment rate fell to 4.2%. The rapidly tightening labor market and persistent inflationary pressures pushed the Federal Reserve to adopt a more hawkish stance. While the Federal Open Market Committee (FOMC) voted to maintain the current federal funds target rate at a range of 0.00% – 0.25%, it announced plans to accelerate the tapering of asset purchases from $15 billion to $30 billion per month, beginning in January. This suggests the FOMC will conclude tapering by March 2022, paving the way for additional rate hikes next year, with the median member now forecasting three hikes in 2022.
In 2021, Chinese equities significantly underperformed global equities contributing to the 25% underperformance of emerging market equities vs. developed markets. More supportive fiscal and monetary policy and a less restrictive regulatory environment should provide a better backdrop for the region in 2022.
Due to the spread of Omicron, the first quarter of 2022 could be challenging for the global economy. Continued pandemic-related restrictions could coincide with disappointing economic data. So far, the market has largely been willing to look through the near-term risks but any further disappointment on the virus front could lead to increased market volatility.
Investors will have to stay broadly diversified to make sure their portfolios are generating the returns they need. However, over the next 12 months, if the hit from Omicron is short-lived, the prospect of another year with above trend GDP growth and rising corporate earnings probably still justifies an overweight to equity risk in portfolios. But, Omicron, structural inflation threats and normalizing fiscal and monetary policy are risks to watch.
Source: J.P. Morgan Asset Management, Global Markets Insights Strategy Team, published January 4, 2022