The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2022 Outlook:
- U.S. economy: Slower growth and inflation compared to 2021, but still pretty fast.
- Global economy: Showing signs of heating up thanks to accelerating vaccination rates.
- Policy watch: No more stimulus, but the Fed isn’t likely to raise rates too quickly.
- Fixed income: Expect further challenges for rate-sensitive assets; consider assuming more credit risk.
- Equities: Our cyclical tilt includes U.S. small caps and non-U.S. developed market shares.
- Asset allocation: Although valuations appear relatively full across many segments, we’re leaning toward risk-on positioning.
Quote of the week:
“The older you get, the better you get. Except if you’re a banana.” – Betty White
A look back at 2021
Last year ended on a high note for investors, thanks to a solid “Santa Claus” rally in global equities and other risk assets, in addition to mild moves in interest rates. While the historical tendency of stock prices to rise during the final week of December and into the new year was on full display, 2021 as a whole was full of ups and downs, with each quarter punctuated by several defining factors. We outline some of these key developments here.
- Democratic victories in both of Georgia’s U.S. Senate runoff elections created the opportunity for expanded fiscal stimulus.
- GDP growth forecasts were revised up rapidly and significantly, driving outperformance by cyclical (i.e., economically sensitive) sectors such as financials and energy.
- The yield on the bellwether 10-year U.S. Treasury surged 81 basis points (bps), to 1.74%, at quarter-end.3
- Inflation readings started to outpace expectations, fueling speculation that the Federal Reserve might begin raising interest rates sooner rather than later. Investors, however, shrugged off inflation concerns and focused on economic growth. GDP expanded at a 6.7% annualized rate during the period, among the fastest accelerations in nearly 20 years, and the job market kicked into high gear.4
- Growth stocks outperformed value shares after lagging badly in the first quarter, as investors sought companies with stronger profit-making potential.
- The 10-year Treasury yield reversed course, falling 29 basis points, to 1.45%.5
- The Delta variant slammed the brakes on the U.S. economic recovery, with GDP growth declining to 2.3% (annualized) in the third quarter.6 Meanwhile, year-on-year inflation rates continued to rise, matching levels not seen since 2008.7
- Saddled with a crushing debt load of $300 billion, Chinese real estate company Evergrande warned creditors that it might default on its loans. Because of Evergrande’s size, investors feared such defaults could be ruinous for China’s property market, with spillover effects to financial markets worldwide.
- Many asset classes, including U.S. and non-U.S. developed-market equities, high yield debt and investment-grade bonds, finished the third quarter essentially flat. In contrast, hot inflation spurred demand for TIPS (Treasury Inflation-Protected Securities), one of the period’s top-performing categories.8
- U.S. economic data for October was particularly strong. Service-sector activity surged to an all-time high, and consumer spending, which makes up about 70% of U.S. GDP, hit a seven-month peak.9
- Global equities rallied despite a hawkish turn from the Fed, which in November announced that it would reduce its monthly quantitative easing bond purchases and a month later that it would double the pace of this tapering. Additionally, most Fed officials projected three rate hikes in 2022, up from less than one when they released their previous set of projections in September.
- Despite the unique mixture of concerns about the surging Omicron variant, overall economic optimism boosted stock market sectors such as technology and real estate to close the year.
- In December, retailers were expecting revenue losses between 5% and 20% from the previous 18 months because of supply-chain issues, translating into billions of dollars in lost sales.10
So amid these developments, how did major asset classes perform for the year? All told, not badly.
- Staying in the “States” paid off. The S&P 500 Index rose 28.7% in 2021, easily outpacing non-U.S. developed-market stocks (+11.3%) and emerging-market (EM) equities (-2.5%).11The dispersion of returns across global equity markets was unusually high, especially for a year in which economic growth worldwide was the strongest in decades. Idiosyncratic risk in emerging markets — chiefly China — dragged down EM sentiment. So did rolling COVID-19 restrictions, especially during the Delta wave, which peaked in August and September.
- Bigger was better. Large caps (+27.9%) bested both mid caps (+22.6%) and small caps (+14.8%).12
- A tip of the hat to TIPS and “hi” to high yield. With inflation at elevated levels throughout the year, investors flocked to TIPS (+6%), among the strongest performers. Meanwhile, historically low default rates, along with the search for income, helped high-yield bonds finish close behind (+5.3%). Dollar-denominated EM debt (-1.7%) lagged significantly, as a strengthening greenback made it more difficult for issuers to pay off these bonds.13
U.S. assets benefited from (1) strong and steady consumer spending, (2) the world’s least-restrictive pandemic regime, which kept businesses open and (3) accommodative monetary policy from the Fed, arguably the world’s most dovish central bank (up until its December meeting, anyway).
Generous fiscal policy helped the U.S. economy grab the global growth baton in 2021. The $1.9 trillion American Rescue Plan (ARP) helped keep businesses and families afloat. The combination of stimulus checks and extension of unemployment insurance (both key provisions of the ARP), in addition to pent-up demand for goods and services, drove consumer spending.
Data problems mask a strong (but tight) U.S. labor market
COVID-19, unusual hiring patterns over the last two months of the year and the quirks of holiday seasonal factors have been making it difficult to interpret monthly changes to the U.S. job market. December’s employment numbers, released this past Friday, were similar to November’s in a few ways.
- The top-line payroll gain (+199,000) was well short of the consensus estimate (+450,000). This figure is from the “establishment” survey, an estimate of payroll and compensation changes based on data from employers.14
- In contrast, the “household” survey, which polls individuals about their employment situations, painted a far more robust picture, indicating that an estimated 651,000 people started new jobs in December.15
- Upward revisions to the previous two months of job creation were substantial (+141,000 in October and November combined).16
Meanwhile, the number of unemployed workers fell by nearly half a million in December, helping to lower the unemployment rate from 4.2% in November to 3.9%, just above its 3.5% pre-pandemic bottom.17
The employment-to-population ratio continued to tick up, providing a bit more slack in what remains a worker-starved jobs market. At 59.5%, this ratio is still significantly below its February 2020 reading of 61.2% but much higher than its April 2020 trough of 51.3%.18 Demographics alone should drag this figure down over time, although the “trend” level of employment as a percentage of the population is difficult to estimate, with the outlier effects of the pandemic still being keenly felt.
While we won’t see the full effects of the Omicron wave until January employment data is released on February 4 — more on that below — national COVID-19 cases surged during the December reporting period compared with November. So fears of the virus also likely contributed to the weaker-than-expected payroll growth, as did tightness in the labor force.
Amid these crosscurrents, we’re paying less attention to the monthly payroll gains, which seems to be badly distorted by seasonal effects, and looking more closely at the broader picture of fast wage growth and greatly diminished labor market slack.
Looking ahead, a number of factors could make January’s report especially interesting. The typical seasonal effects (i.e., temporary holiday workers being let go) may not materialize, while a strong counter effect —Omicron — could lead to less hiring and fewer people looking for work.
Without the Omicron variant, we’d anticipate job creation in excess of 1 million next month, but given January’s explosion in case counts, a decline in payrolls is a possibility.
How might January’s employment data affect the Federal Reserve’s timetable for raising interest rates? Even dovish Fed members probably have to admit that the mounting evidence of a truly tight labor market justifies a move to tighter monetary policy at some point soon. But how soon and how fast rate “liftoff” will be depends on the path of inflation from here, which is primarily at the mercy of the virus and global supply-chain bottlenecks, neither of which Chair Jerome Powell and his colleagues can control.
Still, despite what we believe will be a soft patch for economic growth in the first quarter, fed funds futures indicate that markets are looking for tightening to begin in March. (Fed fund futures are used by investors to bet on the direction of interest rates.) In our view, while a March rate hike is more likely than it was before this latest jobs report, the anticipated slowdown in the first few months of the year could provide the Fed with a rationale to wait until June or July to act.