Hopes that change will bring opportunity

Uncertainty and fear at the start of the year but hopes that change will bring opportunity

Another year has passed, and most investments performed well, but the year was certainly not without incident! The context for everything that happened in 2021 was the ongoing battle against Coronavirus and feeling our way on a path toward 'normal'. Omicron took the baton from Delta and with it changes to severity and spread. Businesses and governments have had to adapt to challenging working conditions, but vaccines have allowed a lighter touch approach to managing the virus which, away from much prised personal freedoms, has allowed the economy, profits and share prices to continue the recovery path.

The economic recession caused by COVID-19 and lockdowns was unprecedentedly harsh but also narrowly focused, mostly on the physical customer-facing service sectors. Demand for physical products and digital services boomed as consumers found themselves rich in time and cash from reduced commuting and socialising, while a combination of enhanced unemployment benefits and rising pension fund values in the US seemed to incentivise people to leave their jobs. Therein lay the beginnings of the huge demand and supply mismatch of 2021, which caused shortages of goods and employees but soaring demand for many products, actively fuelled by economic stimulus. Many companies also misjudged demand and reduced inventory accordingly. Shortages of semiconductors caused knock-on shortages of vehicles, sending used car prices soaring. Across the spectrum of energy resources supply was tight everywhere. Oil production had been reduced by OPEC+ which was reluctant to raise supply again when emerging COVID-19 strains could undermine transport demand in unpredictable ways and of course ESG considerations has also moderated investment in Oil and Gas projects.

2021 ended with a focus on inflation, knock on concerns about the impact on interest rates and future  bond yields and the impact that this might have on the discount rate on the valuation of growth companies. Consequently, markets have hit a bit of volatility at the start of 2022, and beneath the surface there has been some more pronounced turbulence in individual names, regions and sectors.  

Somehow, the headline-style indices fail to capture the stock picking challenges which have beset fund managers for the last few months. Over the course of last year, five large cap technology-based stocks (Meta (Facebook), Apple, Amazon, Microsoft and Alphabet) contributed a third of the 29% return on the S&P 500. What unites them is size and liquidity and there was a feeling in markets that the latter was particularly important as investors fled bonds. Away from this most of the worst-performing stocks came from the disruption or high growth technology stocks; Zoom, Crowdstrike, Snap Inc, Peleton, Zillow, Pintrest and Wayfair fell double digits with others like Salesforce, Etsy and Moderna way off highs recorded. This year, though, the dispersion in performance within just the technology-enabled companies has been stark but the overspill is something that investors will have to deal with too. It's another reason why we ask investors to be patient and long-term as you can have periods where the value in change is hard to reflect. 

What is happening in the US?

The start of 2022 feels very much like Markets are hanging on every word of the Federal Reserve. The December policy meeting showed Fed officials were concerned about inflation, saying the pace of price increases and supply bottlenecks could continue well into 2022. Together with a tight labour market, the Fed might need to raise interest rates and reduce its holdings of Treasury bonds and mortgage-backed securities sooner than expected. With US consumer price growth above 7% for December, this served only to stoke the flames and Fed Chair, Jay Powell, has warned “high inflation is a severe threat to achieving maximum employment” and reaffirmed the Fed’s willingness to move away from the highly accommodative policy that have underpinned the pandemic recovery. Despite the potential for inflation to upset the employment applecart going forward, the US unemployment rate continues to drop and fell by another 0.3% in December to 3.9%, close to its pre-pandemic level of 3.5%. All eyes will be on March where it seems likely that the first US rate hike will happen, and economic stats should have moved away from the initial Omicron shocks.

What is happening in the UK?

It is a similar story in the Eurozone and UK with higher-than-expected 5.0% inflation in the EU in December, a new record high. Energy prices were 26% higher than a year earlier, although this was a slight slowdown from the previous month The latest data could add pressure on the European Central Bank (ECB) to raise interest rates and make strides away from negative bond yields. In the UK, house prices surged 9.8% in 2021 though, with the Bank of England having already tightened policy with a modest but noisy rate hike in December. It seems likely that the Bank of England will take account of overseas monetary policy movements as it formulates what next.  

Against a background of uncertainty regarding inflation, interest rates and valuations you might think that it’s a time to be fearful. However, if 2020 showed anything it is that change brings opportunity and we expect that theme to continue in 2022, albeit with more noise and volatility in the short-term.

Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at Brewin Dolphin).