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- Long-term returns have been very healthy overall, especially for those exposed to developed-market equities. Practically all developed-market countries delivered strong positive performance, with the US, UK, Europe, and Japan all enjoying high double-digit returns in 2021.
- In 2021, a few bright spots included the resurgence of Energy and Financial companies. Defensive sectors such as utilities and consumer staples struggled but produced positive absolute returns in aggregate.
- Emerging markets were among the biggest laggards, with Chinese technology companies falling quite heavily. Emerging-market debt has also struggled, given rising inflation and interest-rate hikes in many emerging economies.
- Defensive assets experienced among their worst returns in a decade, with rising inflation and pro-growth sentiment hurting government bonds particularly. Cash acted as a drag on total portfolio outcomes, given the rise in growth assets.
- Looking ahead, the supportive environment is evolving quickly and requires a watchful eye.
It was another strong period for equities in the December quarter despite the risk posed by the emergence of yet another COVID-19 variant. Although case numbers started to grow significantly, the now high rates of vaccinations and the somewhat less threatening variant meant that economies could remain largely open. Inflation was a key talking point as in the US, consumer and producer prices started surging the most seen in years. The MSCI World Ex-Australia NR Index finished the quarter slightly up at 8.2%, in local currency terms. This saw 12-month returns in the order of 29.0%, with some markets, notably key indices in the US, hitting all-time highs mid-quarter. In Australian dollar terms, quarterly returns were 4.0% due to the falling Australian dollar, while currency movements detracted slightly from 12-month returns (+27.8%) for unhedged investors.
All bar the Communication Services sector was positive over the December quarter, lead by IT (13.5%), Utilities (11.8%) and Real Estate (11.0%), all measured in local currency terms. Over the 12 month period, Energy remained the highest returning sector (41.2%), followed by IT (31.2%) and Real Estate (31.2%). The 12 month returns in Energy, albeit reduced from the previous quarter, reflect the enormous strength in commodity prices seen over 2021 (oil was still up over 50% over a 12 month period as at the end of December).
US shares ended the quarter returning 11.0% in local currency terms, a solid retrieval from the negative month of September. The Federal Reserve all but confirmed the end of Quantitative Easing in the first quarter of 2022, and many market pundits are predicting up to three rate rises in the US in 2022. Recent comments by the Federal Reserve have been largely positive in the wake of the strong inflation numbers in the fourth quarter, noting that supply constraints should ease, thus reducing inflation, however, labour market conditions were mentioned as needing to improve slightly. Over 12 months, US shares returned 26.5% in local currency terms, broadly consistent with other major developed markets and major indices. Europe ex-UK and the UK returned 23.5% and 19.6%% in local currency terms, respectively.
Only time will tell what investors remember most about 2021. Perhaps it’ll be the buoyant stock market, with some key markets delivering 20%+ gains, but many will likely remember 2021 as the year that inflation returned with some fury. These outcomes were considered unlikely by market participants last year, showing the importance of diversified and robust portfolio positioning.
Australian shares were relatively flat over the quarter, with the ASX200 index returning 2.10%. Sectors in Energy, IT and Financials weighed on the index, returning -7.5%, -4.6% and -2.1%, respectively.
Key stats (ASX 200) (12-month returns in brackets): +2.1% (+17.2%).
Bond yields softened slightly over the quarter (the US 10-year bond yield finished the quarter around 1.51%), though the gyrations were quite high given the inflation prints and concerns around the sustainability of the current economic momentum as the Omicron variant surged. This saw declines in the global benchmark index.
Key stats in local currency terms, (12-month returns in brackets): Australia: -1.5% (-2.9%); Global: -1.3% (+1.1%).
Global property & infrastructure
Domestic and global listed infrastructure performed relatively well as economies continued their reopening. However, returns from global listed property were more muted.
Key stats (in AUD terms) (12-month returns in brackets): Australian listed property: +10.0% (+27.0%); Global listed property: 10.1% (+28.6%); Global listed infrastructure: +4.4% (+13.6%).
The US dollar depreciated slightly against most major currencies on the back of the inflation scenario being more pronounced over.
Changes to the Balanced Portfolio over the December quarter
- The fund maintained its exposure to risk assets over the quarter.
- In International equities, more profits were taken in Energy and financials, and we increased exposure to defensive equities via US Consumer Stapes.
- We didn’t materially change the Australian equities exposure after reducing its overall allocation last quarter. We continue to see Australian equity valuations are less attractive relative to several global peers.
- As always, we are seeking to remain opportunistic and focus on market segments with embedded value whilst being considerate of valuations in several developed markets that are expensive relative to history.
Positioning & Outlook
Overall, 2021 will be remembered as a great year for growth investors but a difficult year for defensive investors. Developed-market stocks delivered exceptional performance while bonds and emerging-market assets delivered muted (and, in some cases, negative) returns.
Under the surface, though, there were a few notable changes that affected investor portfolios. To illustrate the underpinnings of the performance in 2021, it was a story of two halves:
- In the first half of the year, economic reopenings and coronavirus vaccinations drove a rally in value-oriented stocks. Many companies that had been decimated by the pandemic, such as travel companies, began to bounce back, and industrial and materials stocks had strong showings in the first half of the year. Developed-markets financials, Energy, and consumer discretionary stocks all increased as confidence in the economic recovery grew, but emerging-markets stocks didn’t keep up in those sectors.
- The second half of the year was a different story, as inflationary pressures, the prospect of tightening monetary conditions, and the resurgent pandemic threw cold water on the rally, especially in emerging markets. Developed-market equities continued to rise but saw greater volatility as the year came to a close.
Broadly expensive equity markets lead to stock selection being particularly important. We continue to look for investments that appeal and believe are key to contributing to your portfolio returns over the longer term. To that end, we have sought investments whose valuations are relatively attractive, including European Energy and US and European financials. We have also continued adding to non-cyclical companies that should prove resilient now that we can see evidence of higher inflation. Among these are US consumer companies and Japanese industrials.
Investors are likely feeling quite confident as we enter 2022, which we’d prefer to see mellowed. While strong returns are always embraced, investors are being asked to weigh stern challenges in the years ahead.
Omicron, inflation and higher interest rates top the list of investor concerns, while stretched valuations would hint at a narrowed opportunity set. As we look ahead, it is important to remember that the future holds a wide range of possible outcomes and is typified by unyielding complexity that continually defeats those who seek to make confident forecasts. Fortunately, our role as investors is not to forecast the future but rather to construct portfolios that empower members to reach their goals, whatever the economic and market conditions. In every situation, the right approach is to view the future probabilistically and think long term.
As advocates of great investing, we must collectively resist impulsive actions and understand that the road won’t be straight. Accepting some volatility is a prerequisite for good returns in any market, but today’s market arguably requires greater care than usual. In our view, this necessitates us to target the best assets for wealth creation and preservation, with careful sizing and smart diversification.
The Balanced fund maintains a healthy cash holding which offers a buffer against equity market pullbacks while providing the resources to take advantage of asset price weakness which offers attractive long-term expected returns.
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Past returns are no guarantee of future performance, and investment returns of less than one year should not be relied upon as any guide to future performance.
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