Down Shifting into a Year of Transition Ahead…

Looking back, 2021 proved to be a year of extraordinary global economic growth. The global economy is estimated to have expanded at 5.6% in 2021, which would be the fastest pace since 1980.[1] As a result, the global equity markets were rewarded, concluding a third straight year of double-digit annual growth, with the S&P 500 and MSCI ACWI finishing up 29.41% and 18.77% respectively for the year.[2]

However, looking at the headline numbers only tells part of the story. An investment implication of the pandemic has been the severe rotation between cyclical value reopening stocks when COVID cases are falling, and stay-at-home growth stocks as COVID cases are rising. Looking beneath the surface reveals the divergence and bouts of rotation that took place, particularly during the second half of the year. After a solid first half, the trend turned negative for small-cap stocks, which underperformed their large cap brethren as measured by the Russell 2000 Index, which rose 14.8% for the year.[3] Small-cap weakness was particularly focused on the small-cap Russell 2000 Growth universe and its fast growing, unprofitable constituents, which underperformed their Russell 2000 Value counterparts by 25.4% - the second biggest spread on record.[4] Emerging market stocks proved to be a laggard for the year, slipping -2.54% as measured by the MSCI Emerging Market Index, marking the worst underperformance compared to the US in 23 years.[5] China led the decline in emerging markets assets, thanks in large part to unexpected regulatory crackdowns on the country’s biggest tech names and the lingering effects of COVID.

The Federal Reserve began tapering its monthly bond buying program in November, and it is expected to conclude by the second quarter. While monetary policy remains accommodative, it is largely anticipated that the Fed will begin raising short-term interest rates later this year, with the possibility of three hikes in 2022. Now that the Fed has telegraphed a hawkish posture, the focus will become the release of new economic data and how quickly the Fed reacts. If inflation pressures remain stubbornly high, the Fed could be forced to begin raising rates earlier. Given its dual mandate, raising rates ahead of achieving full employment is a decision the Fed desperately hopes to avoid. The Fed will be walking a tight rope in 2022; hiking rates too early risks derailing the economy in subsequent quarters. However, if the Fed waits too long, it risks potentially being forced to make larger or more frequent hikes in the future.

November ushered in a bout of stock market turbulence that was driven by pestering global supply chain bottlenecks, COVID variant fears, and the prospects of fading fiscal stimulus. As the economic cycle matures, we would expect this volatility to persist. Providing some historical context, the median MSCI ACWI Index rally has lasted 143 days prior to a normal 10% decline.[6] The current advance has been more than three times as long. For further context, since 1980, the average intra-year decline for the S&P 500 has been 14%, with stocks finishing in positive territory 76% of those calendar years.[7] Therefore, while predicting the timing of any pullback (particularly during a maturing economic cycle) is near impossible, historical market cycles suggest that greater volatility is more likely in the first half of the year as the market anticipates a transition to a more restrictive monetary policy regime. Despite looming headwinds, according to data compiled by Ned Davis Research, a fourth consecutive year of double-digit growth would not be unprecedented. The periods of 1982-1986 and 1995-1999 included five straight double-digit growth years for global stocks as measured by MSCI ACWI Index.

Overall, we remain positive on the outlook for global equities and risk assets as we enter 2022. This has remained our posture since fall of 2020. Any decision to alter this positioning will be assessed through the prism of our asset allocation framework and the underlying indicators we monitor.

Looking more closely, the Economic Factors we monitor register a low probability of an imminent global recession with moderating global growth expectations for 2022. Specifically, the OECD and IMF forecast real 2022 global GDP growth of 4.5% & 4.9%, respectively. While growth is forecast to moderate as the expansion matures, it is important to note that these forecasts are well the above the long-term growth average of 3.5%.[8] The global reopening trend continues, and the US is expected to reach full employment by the summer. Vaccination rollouts continue across the globe and corporate as well as household balance sheets remain strong. Winning the COVID battle will go a long way to relieving the global supply chain constraints and stemming the tide of rising inflationary pressures.

Global Market Fundamentals, and specifically US equity valuations, appear modestly above their long-term average. The rest of the world is playing catch-up to the US as the global recovery continues. Non-US markets trade at historically attractive valuations thanks to slower vaccine rollouts in the emerging world and more frequent shutdowns in parts of the developed world. Entering a monetary tightening phase, US government bonds appear unattractive given a looming backdrop of rising interest rates. Corporate earnings growth in the US should moderate after a torrid pace in 2021, but remain solid at 9% for the S&P 500, according to FactSet. Furthermore, a continued environment of near record corporate stock buy backs could further boost earnings.

Technical Market Factors remain positive as the trend for global markets appears to have continued upward momentum. While the collection of technical market factors we monitor deteriorated to a degree during the volatility of the fourth quarter, it was not pervasive or persistent enough to alter the long-term support of an advancing equity market environment.

Investor Sentiment is historically a contrarian indicator. Omicron, rising inflationary fears, and concerns surrounding Fed policy responses have made investors wary. Overall, these sentiment levels lean cautionary which creates a positive market environment with potentially muted investor expectations entering 2022.

The weight of the evidence continues to affirm an overall positive market environment with a healthy recognition that volatility will persist, given the expectations of moderating global economic growth. We are prepared to reduce equity exposure if our concerns over the maturing economic, corporate earnings, and Fed cycles are met in conjunction with a period of continued technical market deterioration. We enter the year maintaining a moderate risk-on posture relative to our strategic global benchmarks with a balance between US and Non-US equities. We are underweight, traditional fixed income with emphasis on flexible and opportunistic bond strategies. We remain focused on maintaining resilient and diversified portfolios that can withstand a range of economic scenarios as the cycle matures.

We look forward to brighter and healthier days in the coming year!

[1] Ned Davis Research

[2] Morningstar Direct

[3] Morningstar Direct

[4] Ned Davis Research

[5] Morningstar Direct

[6] Ned Davis Research

[7] JP Morgan Asset Management, Standard & Poor’s

[8] Ned Davis Research

Disclosures:

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions and investment strategies will affect the performance of any portfolio, and there are no assurances that it will match or outperform any benchmark. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.

New World Advisors, LLC ("New World") is a Registered Investment Advisor ("RIA") with the U.S. Securities and Exchange Commission (“SEC”). New World provides investment advisory and related services to clients nationally. New World will maintain all applicable notice filings, registrations and licenses as required by the SEC and various state regulators in which New World conducts business. New World renders individualized responses to persons in a particular state only after complying with all regulatory requirements or pursuant to an applicable state exemption or exclusion.

Q4 2021 Market Overview