MACRO
As in 2020, Covid 19 dominated global economic activity. The difference was in the key themes (vaccines and reopening instead of infections and lockdowns). Still, the ride was bumpy: restarting turned out to be difficult in certain areas, bottlenecks limited supply normalization and the new streaks (delta and omicron) generated setbacks and made vaccination access a key divider between nations and income groups.
GROWTH
The 2020 lockdowns resulted in the largest drop in global GDP in modern history, followed by a reopening bounce in 2021 producing the strongest recovery in 50 years (5,7% for the US, 6.1% for Asia and 5.2% for the EU). 4Q21 ended on an upbeat note as a rebound in consumer spending was followed by a year-end bounce in factory output, with global GDP posting a robust 6%ar gain for the period. While growth should moderate due to Omicron, the wave drag is expected to look very different than earlier ones, with a lesser impact on global supply and demand.
Inflation: Global CPI inflation, led by the US, accelerated sharply last quarter to an estimated 5.9%ar, its fastest pace over the past quarter century. Notably, services price inflation rose materially above its pre-pandemic pace for the first time during this expansion. Also, a natural gas supply shock accounted for a large portion of the 4Q21spike, concentrated in the Northern Hemisphere, particularly Europe, as supplies were tight, France and Germany phased out atomic plants, coal inventories were low, and China had to buy LNG in order to meet energy demand. It also served OPEC+ to regain control over oil prices, which rose 60% for the year.
POLICY
Aggressive policy stimulus was a key catalyst of the recovery but has bloated public sector debt (up 17%-pts of GDP globally) and central bank balance sheets (up by 21%-pts of GDP in the DM). In December, the Fed and the ECB have indicated their intention to remove monetary accommodation. This however, on different timelines and to different degrees. The Fed has accelerated the taper of its asset purchases to make way for an earlier policy rate lift-off and potentially three rate hikes in 2022. The Fed’s guidance continues to contrast substantially with the market’s pricing that puts implied Fed Funds in 2024 at just around 1.5%, suggesting that the Fed will not be able to raise rates much above 1.5- 1.75%.
MARKETS
2021 marked the third consecutive year in which US stocks posted an annual return above 15%. Commodities were also strong, driven by oil. Energy and real estate stocks outperformed, and European banks had their best year since 2009. EM assets underperformed sharply, and market leadership saw several large reversals. The USD rose 6.4% against the currency basket.
Active managers had a bad year. While the recovery from the pandemic set a positive tone for risky assets, performance of various investment strategies was often thrown off by new COVID-19 waves leading to market volatility, steepening/flattening of yield curves, and style rotations.
PORTFOLIO
We entered 2021 with the same strategy that was successful in 2020: net underweight equities and overweight in small growth companies. Although at the large cap level (Russell 1000) growth and value returned the same for the year (27%), the Russell 2000 Growth index strongly underperformed the Russell 2000 Value index (3% vs. 30%). We had to rotate into large international large caps as the year progressed.
OUTLOOK
2022 will be the year of a full global recovery, an end of the pandemic, and a return to normal economic and market conditions we had prior to the COVID-19 outbreak. This with the backdrop of still-easy monetary policy. For these reasons, we remain positive on equities and commodities, and negative on government bonds. Large cap equities should benefit, while the high-multiple growth stocks should be under pressure as tighter monetary policy should be a headwind. European and Japanese equities should do well, and we are expanding our exposure. Within the US, we like reopening and reflationary themes and beneficiaries of higher bond yields. The risks are higher inflation, the volatility caused by the tightening of monetary policy and oil prices.