Client Letter 2021 Q4

Q4 2021 Market Results

The S&P 500 index was up strong in the fourth quarter.  Looking at a chart for the quarter, you see a brief pullback at the end of November and into December, then another brief pullback in mid-December, but up otherwise.   For the quarter the S&P 500 was up +11.03% making it +28.71% for the year.  International markets were up +2.69% for the quarter and are up +11.26% for the year.  Emerging markets were down  -1.30% for the quarter and down -2.53% for the year.  Bonds were barely up for the quarter +0.01% and down -1.54% for the year.  Short treasuries were down -0.56% for the quarter and down -0.60% for the year.  Bonds continue to struggle with inflation and the Federal Reserve’s (Fed) recent adjustments to its commentary.  As mentioned the last two quarters, the bond situation remains uncertain, but I continue to believe that it will improve as we progress through 2022.

Portfolio Thoughts

Portfolios performed well in the fourth quarter.  Tactical portfolios were up in all risk profiles, though they were slightly outperformed by Strategic portfolios in most risk profiles.  This may have been in part due to the Tactical exposure to commodities which underperformed the real estate exposure in the Strategic portfolios.  Momentum portfolios outperformed all others given the heavy weighting to the U.S. and its continued outperformance compared to the rest of the world.  Capital Preservation portfolios also performed well overall.

As you may recall from last quarter, I commented that September has historically been a volatile month for the stock market.  And this past September proved to be volatile as discussed last quarter.  But in strong positive market years, as 2021 was, the S&P tends to trend positive into end of year.  That was my prediction, and that’s what happened.  Another good year, making it three years in a row with over 10% gains.  Our phone has already been ringing with clients wondering if this means we will have a market rout in 2022.  Fortunately, my feeling is no.  While I would be surprised to see a fourth year with over +10% gains, I do not see any underlying fundamentals that suggest we will see a major market correction.  I expect a positive S&P 500 for 2022 given the continuing moderation of COVID-19 and the resulting economic recovery.  I’m thinking we will see market returns in a range of +3% to maybe as much as +7%.  I’m also sure we will see some volatility and minor corrections from time to time.  My end of year target for the S&P 500 is 5,000, or about a +5% gain.  Given current economic circumstances, and the lingering pandemic, this is as much a guess as it is economic analysis, but that’s my take for now.

Q4 2021 Notes

I think probably the biggest story for the fourth quarter was the recent emergence of the Omicron COVID variant and how quickly it has been spreading across the world.  Fortunately, this new variant appears to be less deadly than previous variants, though it also appears more infectious than previous variants.  Many experts believe, and I happen to agree, that if the virus has mutated to this point of being less deadly, and much more infectious, it’s a good sign for the shift to COVID becoming endemic.  Endemic means that the virus is here to stay but becomes more of a nuisance than a major public health risk.  Just like the 1918 Spanish Flu evolved to become part of our normal, endemic seasonal flu, COVID may evolve to become part of that seasonal flu norm.   Part of the reason for this optimism is that new COVID case counts have been climbing quite fast here in the U.S.  With new case counts well over 100,000 per day the majority of our population will soon have virus antibodies, from either vaccination or infection.  This can lead to the often mentioned “herd immunity”, which is another way of saying the virus is endemic.  It’s too early to know if this will be the virus trajectory, but I think the chances are reasonable.

Politically, the fourth quarter proved to be important.  Joe Biden and Democrats have been working hard on the Build Back Better legislation that promised increased social spending, attention to climate change, and tax hikes to help pay for it.  The House of Representatives passed the bill on November 19, 2021.  However, the legislation stalled in the Senate in part because it got mired in some questionable math with federal programs that would be initiated but then terminate after just a few years to reduce the 10-year projected costs.  Experienced politicians know that once a federal program is in place, ending it is nearly impossible.  So, eliminating those costs in just a few short years is not realistic.  This suggests the bill’s budget was being manipulated to improve its public acceptance.  In the end, Joe Manchin, a Democrat from West Virginia, officially killed the legislation by saying he would vote “no”.  Democrats have a 50/50 split in the Senate and thus require every vote (ties are broken by the Vice President, a Democrat expected to vote along party lines).  This is important because Joe Biden has placed much of his agenda’s legitimacy on Build Back Better, and it is now in serious danger.  It is very possible a revised version of the bill could be negotiated that would bring Joe Manchin back on board, but that remains to be seen, and if that revised bill has substantially less social spending than the original bill it may not live up to Joe Biden’s promises, or the expectations of the progressive wing of the Democratic party.  Personally, I feel Democrats and Republicans should be taking a victory lap for the $1.2 trillion bipartisan infrastructure bill they passed last quarter.  I wasn’t a big fan of Build Back Better adding another $1.75 trillion in federal spending a year after the American Rescue Plan of 2021 became law with $1.9 trillion in COVID recovery spending.

Globally, the latest issue of concern is the Russian build-up of troops along the Ukrainian border.  Vladimir Putin appears to be threatening to invade if his recently released “Draft Agreement” demands are not met.  The draft agreement has been provided to the U.S. and NATO with, essentially, demands for not expanding NATO membership or any military capabilities further east toward Russia.  It’s not likely that the U.S. or NATO will agree to permanently end its member expansion, but the draft agreement may be a negotiating starting point.  It’s important to remember that when the Soviet Union was in place, Ukraine was part of that geography.  And the eastern Ukrainian border is only 300 miles from Moscow, so the idea that Ukraine could become a NATO member at some point means that Russia’s top adversary is only 300 miles from its capital city.  Personally, I think that qualifies as a legitimate security concern for Russia and is no doubt the reason they are semi-occupying the eastern Ukrainian Donbass territory since 2014.  It’s hard to say exactly where this will go, but it puts a significant diplomatic challenge on President Biden’s doorstep.  I think Russia understands the risks involved in a major invasion, but they also understand the serious security concerns at play since the dissolution of the Soviet Union.

As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio.  If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim