04 January 2022 | William Buckhurst
2021 A Year in Review
2021 was a year of great recovery following the sharp downturn triggered by the onset of Covid and subsequent lockdowns in early 2020.
Impressively, the global economy had already got back to its pre-pandemic highs by the third quarter of 2021, marking the 2020 downturn as one of the shortest and sharpest in history. The OECD now projects global GDP to grow by 5.6% in 2021, having shrunk by 3.4% last year. The rapid rollout of vaccinations in the UK and other developed countries helped activity to return to more normal levels while government stimulus programmes turbo-charged consumer spending across the globe.
Even the onset of the highly transmissible, but potentially less harmful, Omicron variant at the end of the year looks, so far, to have done little to stall the recovery – global stock markets certainly appear to have taken the recent resurgence of the virus in their stride. It remains to be seen, however, how tough government responses to the new variant will be. In the UK, we have a beleaguered Prime Minister determined to avoid new lockdown measures and encouraging sounds from politicians that no further restrictions will be required. Meanwhile France has made working from home compulsory three days a week, yet the response in America has been less severe despite record cases: the traditional New Year’s Eve celebration in Times Square, New York, went ahead, albeit a heavily reduced turnout.
Global stock markets’ response to the economic recovery has been impressive to say the least. World indices returned 23% over the year, although once again the UK index of leading 100 companies lagged and was up by 14.3%. The US recorded one of its best years ever with the S&P500 up by 30% in sterling terms. The capital markets exuberance of late 2020 spilled over into 2021 as companies raised a record $12.1 trillion in new share and bond issues, up almost 17% from 2020, which was itself an historic year. Massive bond-buying programmes launched by central banks during the depths of the pandemic helped push borrowing costs to historic lows. This, in turn, resulted in tremendous private equity activity where the likes of KKR, Apollo and Blackstone borrowed through credit markets to fund buyouts that have totaled some $1.1 trillion this year alone. Here in the UK, a depressed currency and cheap stock market saw, amongst others, the British grocer Morrisons and infrastructure group, John Laing fall prey to overseas bidders. Various data points suggest that listed equity funds have taken in more cash this year than in the previous two decades combined, which is an astonishing figure if correct.
But beneath the calm, headline inflation numbers - traipsing along at a whimper for so long - began to roar. A combination of a sharp increase in consumers’ appetites for goods (often purchased online while stuck at home) and a continuation of Covid induced disruption to global supply chains conspired to drive prices markedly higher. Annual inflation in the US hit a 39-year high in November as the effects of the pandemic triggered persistent supply-chain snarls and labour shortages. “Not since the release of (Michael Jackson’s) Thriller have inflation pressures been this strong in the US” TD Economics wrote in a note to clients in December.
Although wages are also climbing as a result of worker shortages (in the UK, 2,000 workers made redundant by Honda in Swindon in July were taken on by Amazon with hiring bonuses of up to £3,000 and starting pay more than £2 higher than the legal minimum), they are not keeping pace with rising prices and this has the effect of squeezing lower-income households. It was notable that by November the US Federal Reserve had dropped their persistent use of the word “transitory” to describe the inflation spike, and by the end of the year they had outlined a series of rate hikes for next year and the year after. Meanwhile, the UK became the first of the major Central Banks to raise interest rates (from 0.10% to 0.25%) on 16th December. In Europe, the ECB stood alone in remaining accommodative, trying its hardest to convince everyone that it won’t be raising rates at all next year.
In response to higher than anticipated inflation, global bond markets have had their worst year since 1999. The Barclays Global Aggregate Bond Index - a broad benchmark of around $68 trillion of sovereign and corporate debt - has delivered a negative return of around 4% in 2021. The decline has been largely driven by two periods of heavy selling: at the start of the year, investors dumped longer-dated bonds in the so-called “reflation trade” as they bet the recovery from the pandemic would usher in a period of sustained growth and inflation. Then in the autumn, shorter-dated debt begun to sell-off as the market begun to price in higher rates.
But on a longer-term view, bond markets remain remarkably complacent in response to higher inflation and it appears the market is still unprepared to 'Fight the Fed' despite a more hawkish tone emerging from some of its members. This is particularly apparent in riskier parts of the credit universe. The average yield of US high-yield bonds spiked to a peak of over 11% in March 2020 but fell to a record low of under 4% earlier this autumn. Despite a recent bout of bond market volatility triggered by rising inflation concerns, junk bonds still offer on average a fairly unappetising yield of 4.4%.
In the equity markets, the apparent calm of headline indices at record highs betrays more volatile patterns emerging beneath the surface. A lot of the more popular trading or “meme” stocks have now fallen sharply from their highs earlier in the year. This is perhaps best illustrated by Cathie Wood’s ARKK Innovation Fund, proclaimed by many as the top fund of 2020, yet fast forward to the end of this year and lockdown winners such as Peloton Interactive, the high-tech treadmill company, and Robinhood, the share trading app, are down over 70% from their highs. Other traditional value sectors such as Oil and Gas and Financials remain well below their historic highs and available to purchase on cheap valuations, yet the growth companies continue to dominate. Currently, the top ten stocks in the S&P500 index comprise more than one third of the entire index. In other words, a 1% gain in the top ten stocks is the same as a 1% gain in the bottom 90%. Such has been the story of 2021. Had it not been for the enormous returns in companies like Apple, Microsoft, and Alphabet, it would have been a very different year for many investors.
Another area that experienced sharp losses this year was China. After decades in which private businesses and entrepreneurs were encouraged, President Xi carried out a sharp handbrake turn, moving the party leftward and reconnecting with its Marxist roots. While regulators in the US have failed to curb the relentless growth of technology companies, an authoritarian regime in China was, in one fell swoop, able to bring large internet gaming, food delivery and online shopping companies such as Tencent, Meituan and Alibaba to heel. The Chinese so-called Common Prosperity Policy has scared many investors and it feels as if China’s ongoing anti-monopoly campaign is part of a larger global push by regulators against big tech.
At times it felt as if Chinese technology stocks spent much of the year ebbing and flowing with the whereabouts of Alibaba founder, Jack Ma, whose disappearance late last year heralded the start of a prolonged sell-off in the sector. At one point in October a mere sighting of him in Hong Kong and then Spain sent the sector 10% higher in a week. We also saw the Chinese authorities begin to grow concerned over a number of property developers which they saw as being poorly managed and having excessively high levels of debt. The government’s response was to put a number of policies in place to rein in the more highly levered developers including limiting access to new credit and curbing mortgage issuance by banks. More recently, authorities have moved to stem some of the tightening by reducing banks’ reserve ratios and we have seen a recovery in Chinese indices. Despite the clampdown in certain sectors, the outlook for economic growth in China remains very strong. Its population is getting wealthier, better educated and more innovative. China continues to be a powerhouse of global growth and has now matured into a domestic, demand driven economy.
Turning to other emerging markets, Indian equities were one of the best performing asset classes of 2021. Having dealt successfully with the dramatic surge in Covid cases earlier in the year (government data now suggests the entire adult population will be vaccinated by March 2022), the ruling party’s ‘Make in India’ campaign is encouraging global corporates to transfer their manufacturing to India. It is rumoured that Samsung now plans to relocate some of its smartphone manufacturing capacity to India this year.
In commodities, precious metals were weak - perhaps surprisingly given the negative real rate available on most bonds, although a newfound appetite from speculators for Bitcoin and other digital currencies may provide part of the answer. Iron ore fell sharply as economic data from its main customer China softened while lithium, a key component for electric vehicles, was the standout winner.
The year closed with equity markets trading around all-time highs but with the debate over inflation still raging. The conundrum central bankers face is that traditional monetary policy tools, such as less quantitative easing and higher interest rates, are less effective in tackling inflation created by lack of supply. As the Governor of the Bank of England, Andrew Bailey said, monetary policy “doesn’t get you more gas, more computer chips, or more lorry drivers”.
Ultimately, ample liquidity has driven financial assets higher. The Federal Reserve publishes monthly data on the total amount of cash held in deposit accounts at commercial banks and that figure is at its highest ever point. The MSCI World Index has now completed its third consecutive year of double-digit returns, its first such hat-trick in over two decades, showing that excess cash in the system has continued to support risk assets.
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