A new year typically brings reflection on the one passed and resolution for the one ahead. The investment world celebrated a solid calendar year for stocks and just as quickly, we hit the reset button for 2022 and started again.
In 2021, we saw the economy recover with strong corporate profit growth, and equities outperforming Wall Street expectations. Building on the tailwinds of an economy that continues to recover, we have seen very strong corporate profit growth, and stocks outperformed other asset classes. What did not do as well included emerging market stocks and bonds. The Bloomberg U.S. Aggregate Bond index fell 1.5%, however, not all fixed income finished in the red – Treasury Inflation Protected securities (TIPs), municipal bonds and some credit strategies ended 2021 positively.
|Russell 1000 Growth||27.6%|
|Russell 1000 Value||25.1%|
|Bloomberg US Aggregate||-1.5%|
|MSCI Emerging Markets||-2.5%|
So where do we go from here? Broadly speaking, we are keeping our eye on inflation and its impacts on interest rate increases and the bond market. The Federal Reserve continues to be concerned about inflation and expectations are that there will be three interest rates hikes in 2022, beginning as early as March. Given where the labor market is, with the current national unemployment rate at 3.9%, the possibility that the Fed hikes are faster and more frequent than what the market is pricing could lead to more volatility. While some experts are questioning whether the Fed will make another policy error by raising rates too much, we posit the Fed has already made a policy error by keeping rates too low for too long. Despite one of the best bull markets in history, keeping interest rates too low during this extended period has distorted valuations for stocks and bonds. At the same, it has removed the Fed from being able to use its main monetary tool for fighting the next recession, by lowering interest rates
A lot has been written recently about the upcoming challenges of the traditional 60/40 portfolio that has rewarded investors well. Invest 60% in stocks, 40% in bonds, rebalance every year and you would have enjoyed an annualized return close to 10% for the last 50 years1. But bond yields have trended down since 1982 when yields were 15% the bull bond market is over. Rising yields mean bond prices are falling which means investors are losing principal. With 10-year Treasury yielding 1.75%, bond investors are in a predicament.
Yes, a rising rate environment is a challenge for bond investors. But let’s also remember that fixed income has, and will continue to have, a role in a diversified portfolio. First, bonds have historically dampened a portfolio’s volatility or overall up and down movement. Second, bonds provide some liquidity and stability during an stock market drawdown. Third, as bonds mature, the proceeds can be reinvested in higher yielding bonds, potentially enhancing the income.
A big part of what Sendero’s research team works on daily is to dissect the drivers of performance for each manager we invest in. Does a manager provide superior returns from stock selection, or were they rewarded for being in the right sector or industry? How is the portfolio positioned going forward? What stocks out/underperformed this quarter, and why?
Asset class returns and volatility expectations are measured versus their historical and peer universe. As we formulate our market assumptions and outlook, all these factors – along with some gray hair and skepticism – are then validated or argued into building a portfolio for 2022 and beyond. All investments have pros and cons, and it is easy to get hung up on the past. Being an investor means understanding what drives the performance of each asset in different cycles, making balanced allocation decisions for the future and being comfortable living with those decisions.
If you have any questions or want to have a conversation about the market or your portfolio, please contact Liz, Ed, Fred, Scott, Tyler or myself. Your Sendero team is ready to help
Amaury de Barros Conti
Partner | Vice President Investments
1 The Allocator’s Edge by P. Huber, 2021, pp. 16-17