US Economy: Shopping power.

US GDP growth was revised upward to 2.3 percent in Q3 2021 on the strength of somewhat higher-than-expected consumer spending, a trend that continued through December. Despite concerns about rapid inflation (+4.7 percent core PCE) and the spread of the Covid-19 Omicron strain, US holiday shoppers spent over 11% more in 2021 than in 2019.

US Stocks: Easing Omicron.

Equities in the United States were volatile, owing to a vacillating story surrounding Omicron. Finally, the S&P 500 Index reached an all-time high because to flat Covid hospitalization rates, FDA approval of boosters for children, novel treatment alternatives, and the resiliency of the US consumer. Consumer staples (+10 percent) shone as investors sought lower volatility and more appealing valuations.

Foreign Stocks: Europe strong, EMs lag.

European markets (+6.6 percent) also ended near an all-time high, finishing their second best year since 2009. China (-3.2 percent) dragged down results in emerging markets, which were otherwise comparable to developed markets. Chinese equities struggled in 2021 as domestic credit and real estate markets deteriorated and substantial regulatory reforms were implemented.

Fixed Income: Yields rebound.

The yield on 10-year US Treasuries increased as the Covid forecast improved and there was greater clarity about when the Fed's ultra-easy monetary policy would expire with inflation running high. Fed Chairman Jerome Powell said that the central bank's bond purchases will cease in March 2022 after being reduced by an additional $15 billion per month, and that the Fed funds rate might rise as early as late winter.

Alternatives: Hedge funds hold on.

As expected in a year defined by robust equities returns, hedge funds did not outperform. Nonetheless, despite the "reopening" wave reducing stock distinction and many managers being taken off guard by rising interest rate expectations, hedge funds outperformed core fixed income and aided in portfolio diversification in 2021.

Our Take

Entering a new year always feels like a new beginning, despite the fact that many of the trials and tribulations we have been working through remain right alongside us. Covid is still headline news while supply chain woes and inflation continue to be hot button financial topics. Nevertheless, we are optimistic about a return to more normal conditions in 2022 given new Covid treatments, broader vaccination eligibility and the arguably less severe Omicron strain coupled with persistent consumer spending and stable GDP growth.

Looking forward, additional financial market catalysts include Fed policy and interest rates as well as fiscal policy and regulation, including regarding energy. While it is always difficult to prognosticate, we think we can identify the characteristics of the market regime that these catalysts suggest we are entering and let that inform portfolio construction and stress-testing in our ongoing effort to have in place diversified portfolios containing the right exposures to mitigate risks and capitalize on opportunities. As such, we see greater volatility and cyclically (if not structurally) driven inflation among the most significant challenges ahead. More on this in our Q1 2022 Quarterly Commentary later this month.

What We’re Doing

After a very positive or negative year, it's reasonable to rebalance portfolios in order to maintain the optimal risk-reward characteristics, which we continue to suggest. While values in equities appear to be marginally better internationally, they are not sufficiently better for us to propose overweighting those holdings.

In terms of risk mitigation, given the probability of increased volatility, a position in fixed income and cash is reasonable now, but not at the expense of significantly diminishing portfolio potential return.

Additionally, with equity valuations high and interest rates low, investors will likely have a greater chance of meeting their return targets by investing in private markets (equity, debt, and real assets) that offer a return premium in exchange for limited liquidity. Portfolios may also gain from real assets in particular if accelerating inflation becomes a longer-term concern.

Finally, we believe that environmental and social sustainability is a secular trend that will allow investors to participate in rising market segments while potentially reducing risk. As such, we are identifying new sustainable investment opportunities for our clients via the public and private markets.