Quarterly Commentary Q4 2021: Effects of Omicron on Portfolio Returns
Portfolio results for the last quarter of 2021 were characterized by widely divergent returns across various asset classes. The emergence of the more contagious Omicron coronavirus variant resulted in “recovery” and “value” stock sectors underperforming in the fourth quarter, after doing well earlier in the year. Small-cap and micro-cap U.S. stocks (Russell indices) returned 2.1% and lost 2.7%, respectively, over the last quarter. Conversely, growth stocks (S&P 1500 growth) did well with a 13.0% quarterly return. The growth-centric S&P 500 also had a strong quarterly return of 11.0%.
More economically and currency sensitive foreign developed stock markets (EAFE) and emerging markets stock markets (MSCI) were lackluster performers with quarterly returns of 2.7% and negative 1.3%, respectively.
Long-term Treasury bonds (Bloomberg/Barclays 20+ Yrs) returned 3.5% over the quarter as a result of investors seeking a safe haven asset. However, this same asset over the course of 2021 declined 4.4% as interest rates rose due to inflation concerns. High yield bonds returned 0.7% over the quarter, and emerging markets local currency bonds lost 3.5% over the quarter.
Alternative assets had divergent results. Gold was up 4% for the quarter, but was down 4.3% for the year. Commodities (Goldman index) were up 1.5% for the quarter and 40.4% for the year.
COVID-19 induced supply and labor force shortages, and financial stimulus induced high demand for many products. This resulted in more U.S. inflation than expected. The 12-month CPI through November saw a 6.8% rise and was one reason long-term interest rates rose in 2021.
Preliminary evidence suggests that the new Omicron variant is both more contagious and less deadly than earlier variants. This could be beneficial to society as a whole as herd immunity may be attained in 2022 without a ghastly death toll. Additionally, new anti-viral pills that reduce hospitalizations and deaths by about 90% and are variant-agnostic are expected to become widely available in 2022. Therefore, despite some past illusions about the coronavirus being in serious retreat, this could actually occur in 2022.
As the coronavirus retreats, a new surge in economic activity with lessening inflation could occur. The more economically-sensitive countries (many foreign and emerging markets) and sectors (industrials, small-caps, …) could outperform U.S. large-cap and growth stocks.
Inflation has run hotter than expected, but a significant decline is expected by the end of 2022. However, having some investments that are insensitive to growing inflation is still recommended.
Elevated stock and bond valuations could weigh on returns in both 2022 and 2023. A focus on more attractive sectors and asset classes is recommend in order to avoid potentially large declines from overvalued assets and sectors reversing their more recent positive price trends.
We will discuss some of these topics in greater detail in our upcoming 2022 Economic and Investment Outlook.