Global equities performed well in the final quarter of 2021 as investors focused on positive economic data and corporate earnings projections. The newest Covid variant dented sentiment during November, but the lack of information on the severity of the variant allowed investors to look past the short-term risks and remain focused on a positive outlook. A rosy view for the global economy in 2022 also helped support equity markets and push many indexes to all-time highs. In fixed income, government bonds exhibited relative outperformance as corporate issues were negatively impacted by covid uncertainty and the threat of global central banks entering rate hike cycles. Additionally, the risk-on tone of the quarter led to weak performance for bonds relative to equities. The short-end of the yield curve, which is more influenced by central bank policy, underperformed while the long-end of the curve, which is more influenced by market dynamics, outperformed. The flattening of the yield curve was a sign that bond investors lacked some of the confidence which pushed equity markets higher through the end of the year. Overall, the MSCI All Country World Index rose 6.4% and the Bloomberg Global Aggregate Bond Index fell -0.7%.
Q4 2021 Market Commentary
US equities rose in Q4. Gains were robust despite a weak November, during which fears over rising cases of the Omicron variant and the speed of the Federal Reserve’s asset tapering weighed on risk assets. Data continue to indicate that the economy remained stable and solid corporate earnings which boosted demand for stocks. Technology was the best performing sector along with real estate. These sectors rebounded strongly after initially falling due to fears of faster than expected rate hikes. Value oriented sectors such as energy and financials posted positive but relatively weak returns. At the sector level, real estate was the top performer (16.5%%) followed by technology (16.4%) and materials (14.6%). Financials were the worst performing sector (4.0%) along with energy (6.5%) and industrials (8.2%). Real estate and technology benefitted from a flatter yield curve and the rebound in risk-on demand after a Q3 sell-off. Real estate and materials also benefitted from higher inflation prints. Both sectors have performed well historically during periods of rising inflation. Value oriented sectors underperformed as investors were cautious to add to areas of the market directly impacted by rising Covid cases. Overall, the outperformance for some of the highest weighted sectors at the index level led to strong performance with the S&P 500 returning 10.6%, the NASDAQ rising 8.3%, and the DJIA finishing up 7.4%.
Like the US, Eurozone shares made gains in Q4, as a focus on strong corporate profits and economic resilience offset worries over the new Omicron variant. The region held up surprisingly well after several countries reintroduced restrictions to try and reduce the spread of the new variant. Equity markets drew support from early data indicating a lower risk of severe illness for Omicron patients and robust earnings data and corporate outlooks. Additionally, while the European Central Bank (ECB) gave forward guidance indicating a QE tapering path rate hikes were off the table. The ongoing support from the central bank raised encouraged demand for stocks by helping maintain the high risk premium versus bonds. Euro area performance was positive but was significantly weaker than the US. The MSCI EMU returned 3.7%. In the UK, more severe and rapid spreading of the Omicron variant led to a sharp sell off, but UK equities outperformed their regional counterparts. The Bank of England (BoE) did not help the markets by surprisingly not raising interest rates in November only to then pivot to a more hawkish stance and raise rates in December. The moves whipsawed both equity and bond markets. Ultimately, the markets regained some footing through the end of the year with reopening industries struggling and defensives such as utilities and healthcare outperforming. Overall, the MSCI UK All Cap Index returned 4.7%.
Japan continued to struggle relative to other developed markets. The country has been one of the most affected by covid from an economic and consumer activity standpoint. Investors were also grappling with a new prime minister and the results of an October general election leading to instability in the ruling party. A divided government would have made it more difficult to pass fiscal spending packages designed to boost consumer spending. As a manufacturing and export driven country, Japan also struggled to contend with ongoing supply chain constraints and higher commodity prices. Political and Covid uncertainty led to weak demand for equities. Overall, the MSCI Japan Index lost -3.9%.
Emerging market equities also underperformed in Q4. Ongoing weakness in China was a major headwind for the asset class. China increased the scope of lockdowns to try and fulfill its “zero-covid” policy ahead of next year’s winter Olympics. The lockdowns led to a decline in economic growth expectations. Additionally, the country continued to work through the fallout of defaults in the real estate industry. The MSCI China Index lost -6.0% for the quarter. Other EM countries did little to help the cause. Many EM countries have begun raising interest rates to combat inflation and the combination of higher rates and a stronger US dollar weighed on many markets. Emerging Asian economies outperformed and helped limit broad based losses. Taiwan, Thailand, the Philippines, and Malaysia posted positive results. UAE and Mexico also bucked the trend of some of the more closely followed EM countries while Russia and Brazil were some of the worst performers. Overall, the MSCI EM Index lost -1.7%.
Fixed income underperformed in developed markets as rates began to rise and the hawkish tone of many central banks added a new wrinkle to bond market outlooks. Rate hikes in Canada and the UK, forward guidance from the Fed, and the general bond market reaction to higher inflation in many regions and countries pushed short-term rates higher which weighed on bond prices. In the US, the Fed abandoned the attempt to call inflation “transitory” and set a path for raising rates because of the strength of the economy and to combat future inflation pressures. The US 10-year rate rose slightly from 1.49% to 1.51%. Government bonds outperformed corporate bonds and longer-term bonds outperformed shorter-term. The Bloomberg Long Term US Treasury Index returned 3.1% while the Short Treasury Index was flat. High yield corporates, which are highly correlated to equity markets posted a positive 0.7% return as the risk of defaults continued to decline. TIPS were one of the best performing sub-asset classes as inflation continued to exceed expectations. TIPS are also longer duration securities which means they will be more correlated with long-term debt. The Bloomberg US Treasury TIPS Index returned 2.4% for the quarter. The Bloomberg US Aggregate Bond Index was flat for the quarter.
Overseas, global bonds underperformed with the Bloomberg Global Agg Ex US Index falling -1.2%. Higher rates of inflation led to increasingly negative real yields on foreign bonds, many of which were already yielding negative or close to zero percent. As with the US, corporate bonds underperformed government debt. The ECB and Bank of Japan maintained their dovish positioning, but bond investors still reduced exposure to short-term debt with the expectation that global central banks will begin following the Fed. In emerging markets, bonds issued in local currencies declined significantly. The Bloomberg EM Local Issue Index fell -3.4%. Bonds issued in US dollars performed relatively better although returns were still negative. As inflation pressures ramped up in many emerging economies local currencies lost ground to the dollar. The Bloomberg EM USD Index lost -0.5% for the quarter. Overall, the risk outlook for bonds continued to shift towards the downside and led to investors selling exposure in favor of higher yields and inflation hedges.
Commodities continued their recovery from a mid-year swoon with industrial metals leading the way. Prospects for a stronger rebound and global economic growth story and fiscal spending on infrastructure in 2022 boosted demand for the asset class. Industrial metals were the top performer while the energy markets were the biggest detractor. The Chinese real estate market did not completely recover from the Evergrande debacle the outlook for future spending in the country helped support metal prices. Copper was a strong performer, posting returns of 9.0%. Industrial metals overall posted a positive 8.6% return. Precious metals also performed well as demand for inflation hedges remained high. Headwinds from rising interest rates did lead to some weakness though and led to underperformance versus industrials. Gold returns 3.6%, silver returned 5.9%, and palladium eked out a 0.5% gain. Agriculture was a consistent performer throughout the quarter and ended with a positive 4.7% return. The oil markets were extremely volatile during the quarter as covid headline risks led to a rollercoaster of monthly returns. West Texas Intermediate crude oil prices rose 10.7% in October, fell more than -19% in November, then recovered with a 10.2% return in December. Ultimately the price of oil fell -0.9% for the quarter.
Real estate was one of the top performing sectors during Q4 as demand for yield, inflation protection, and expectations of supply and demand mismatches boosted investors’ confidence in the space. The FTSE Nareit All Equity REIT Index returns 16.2%. Underlying performance within the index was widely dispersed. Mortgage REITs, which rising rates negatively affect, fell -1.3% while self-storage, industrial complexes, and office REITs all posted returns of greater than 20%.
Hedge funds returns were muted in Q4. The volatility in currencies and interest rates created a difficult environment for strategies which focus on longer term value add strategies. Credit (-0.2%) and Macro (-0.5%) strategies underperformed. All other major strategies posted positive returns for the quarter, but relative performance was underwhelming. Event-driven (1.6%) and Equity Hedged (0.9%) strategies were the top performing. Both strategies benefitted from the opportunities of a strong but volatile equity market. Overall, the HFRI Composite Index returned 0.8% through Q4.