Q4 Market Commentary – January 7, 2022

US stock markets had another strong year in 2021 as the economy and corporate profits continued to rebound from the Covid pandemic. US GDP is estimated to have grown over 5% year over year in 2021, and growth in corporate earnings in the US large company S&P 500 index were estimated at more than 45% in 2021 (according to Factset).

However, there were warning signs for the economy toward the end of the year, not least of all the rise of inflationary pressures. Inflation rose from under 3% for much of the last few years to 6.9% as of November 2021 (year over year). Inflation has been elevated since the summer, and the initial talk of inflation being “transitory” has died down.

Inflation has been pushed up by massive government stimulus, Covid-related supply-chain issues, and a tight labor market, the last two of which have been apparent to anyone shopping for a car, or just going out to eat and noticing how overwhelmed the wait staff in restaurants are. The latest Omicron wave will not be helpful in regard to easing supply-chains or adding labor, so expect the problems to persist at least in the near term.

The problem for the markets is that the Federal Reserve will need to address inflation before it becomes entrenched, and that means raising interest rates. Federal Reserve officials are expecting three interest rate increases next year, possibly starting as early as March. Low rates have been fueling stock market increases, so this will be a headwind for the market this year.

Allocation to asset classes like inflation-protected bonds and gold usually are helpful in protecting portfolios from inflation. In fact, inflation-protected bonds outperformed the aggregate bond index by over 8% in 2021. Gold did not yet respond in 2021, as described in the commentary below.


US corporate earnings continued to soar in the most recent quarter As noted above, corporate earnings growth is expected to reach 45% for 2021. Of course, this is from a depressed base in 2020, but even looking at growth in earnings over a longer period – from before the pandemic in 2019 to estimated earnings in 2022 – growth is projected to average a remarkable 11% per year.

For the year, big tech companies posted another very strong performance. Alphabet (GOOGL) soared 65%, Microsoft (MSFT) gained 51%, and Apple (AAPL) jumped 34%. Amazon (AMZN) trailed the rest of the tech market, with a gain of just 2% in 2021. (Note that tech stocks have pulled back some so far early in January due to interest rate fears). Market leadership shifted from small companies to large companies over the course of 2021. In the first quarter, small cap stocks dominated while later in the year, including in the fourth quarter, large company stocks led returns. The Russell 1000 posted a 9.8% return in the fourth quarter (and 26.5% for the year), while the Russell 2000 gained 2.1% for the quarter and 14.8% for the year.

International stock returns trailed US stock returns for the fourth quarter and the year, and emerging market stocks, in particular, did poorly. The EAFE index of international developed stocks gained 2.7% in the quarter (and 11.3% for the year), and the MSCI Emerging Markets Index declined 1.3% for the quarter, falling 2.5% for the year.

China, a large part of the emerging markets index, was hard hit. China’s long record of extraordinary growth came to end – or at least a pause – in 2021. Over the last 30 years China’s economy has grown more than 13% a year (as measured by GDP) while the US economy grew at about 4.5% per year. This past year, the story reversed sharply. China’s economy grew 0.2% in the first quarter, 1.2% in the second, and 0.2% in the third (quarter over quarter). This compares to US growth of 6.3%, 6.7%, and 2.3% respectively.

China has been hit with both shorter term and longer-term hurdles. In the (hopefully) shorter term, it’s been especially hurt by COVID as the Chinese government put more stringent restrictions on its people and did not provide the same level of stimulus as the US. Longer term issues include the government’s tightening regulatory control over its economy and its troubled real estate sector. China has been cutting access to loans in order to reign in the enormous sector, which was seemed in danger of overheating and accounted for a quarter to a third of China’s overall annual growth. As a result, China’s stock market trailed global stock markets by a considerable margin.


The Federal Reserve started the process of ending stimulus measures during 2021 by reducing the volume of monthly bond purchases. It will terminate this bond purchase program altogether in the first half of 2022 and expects to begin to raise the Fed Funds rate in 2022 to combat inflation.

The 10-year Treasury rate ended the year at 1.55%, similar to the start of the quarter, but an increase of 0.62% from the start of the year. Short term rates jumped toward year end as the market prepared for the Fed to raise the Fed Funds rate in 2022. The two-year note rose from 0.28% at the start of the fourth quarter to 0.73% by the end of the year.

Bond returns were generally slightly negative this year, with the Bloomberg Aggregate Bond Index declining -1.6%. However, there were exceptions. Inflation-protected bonds jumped as inflation stayed stubbornly high, and high yield bonds rose as corporate fortunes improved throughout the year.


Many commodities have not yet responded to the inflationary signals in the market. The price of a barrel of oil (WTI) ended the quarter at the same price it started: $75. The price of gold rose very modestly, by 3.6% in the quarter, given the stubbornly high inflation. In fact, gold lost ground over the course of the full year. One possible explanation is that gold often tends to move in the opposite direction of the US Dollar, and the dollar strengthened throughout the year. If inflation persists, look for that trend to change.

Looking Ahead

International stock markets haven’t outperformed the US stock market since 2017. The US stock market has been on such a strong run that there has been increasing concern about stock valuations. Has the US market become too expensive? Our answer tends to be that “expensive” needs to be weighed in relation to other investible assets. And, as always, we believe the best approach is not to try to time the markets, but to diversify risk among the available options.

First, it’s important to look at the overall investing context when asking if markets have gotten too expensive. In a period of falling interest rates and rapid earnings growth, it makes sense that stock prices are a higher multiple of earnings. Relatively speaking, the less the market is paying on bonds, the more an investor should be willing to pay for the dividends and growth of stocks instead.

Second, the roaring US stock market has meant that valuations now differ markedly among global markets. The prices in the US stock market, particularly among large company stocks, remains high because these firms are expected to grow more rapidly. A fund comprised of US S&P 500 companies, for example, currently trades at approximately 21 times their expected combined earnings in 2022. By contrast, international companies (as measured by the MSCI EAFE Index) trade at about 13 times their expected 2022 earnings. Emerging markets, which have been hard hit as explained earlier, currently trade at only about 11-12 times next year’s expected earnings (as measured by the MSCI Emerging Markets Index). Having a portfolio that includes all of these companies offers a mix of expected high flyers along with stocks with more modest expectations (and more modest prices).

As we said last quarter, after a pullback in the month of September, it’s important not to fall into the trap of trying to time the markets. Indeed, markets returned to robust gains in the fourth quarter. Nobody knows what 2022 will bring (despite headlines to the contrary) but in the long run we believe our investors will be well served by a diversified portfolio of stocks, bonds, and commodities. Such a diversified portfolio by definition will never perform as well as its strongest components in the short run, but it will also avoid the fates of its weakest components and should provide steady returns over the long run.