Most broad asset categories have produced positive returns thus far in 2021, with the exception of high-quality bonds that suffered amid a rise in interest rates at the start of the year. Real assets, including energy-related investments and commodities, have been among the top-performers. Within equities, US large cap stocks have continued to provide market leadership while emerging markets stocks have lagged. Against this backdrop, fully invested portfolios have generally produced solid absolute performance results on a year-to-date basis.
Volatility has picked up over the last few weeks as financial markets express anxiety over the future path of monetary policy and the rapidly spreading omicron variant. In his testimony to the Senate Banking Committee on November 30, Federal Reserve Chair Jay Powell finally retired the use of “transitory” to describe inflation and signaled the Fed is considering a faster end to its program of economic stimulus.
In our view, valuations are generally rich while macro uncertainty is high. Therefore, proper diversification remains as important as ever. While there remains a wide range of potential outcomes, our base case assumption is that the economic recovery is likely to continue, though growth may have peaked for the cycle. And the odds of a recession seem relatively low given the strength of consumer balance sheets. However, uncertainty about inflation and the monetary policy response remain key risks. Inflation rates are likely to decline in 2022 due to base effects, but supply-side pressures are likely to keep inflation elevated for some time.
In portfolio strategy, we continue to target an underweight position to core/investment grade fixed income given historically low yields. Within equities, we remain underweight to US stocks given stretched valuations but fully invested in more reasonably priced international and emerging markets stocks. We are targeting an overweight position to “real assets” like commodities and energy-related stocks given the risk of stickier inflation and attractive valuations.
Please see the attached presentation that provides our assessment of the market backdrop and shares our views on portfolio strategy going forward.