The S&P 500 outperformed virtually every stock or bond sector over the past year. Bonds trailed stocks in part because of inflation and the threat of higher interest rates to come. Small cap stocks compared poorly to large caps as COVID continued to affect investors’ appetite for the shares. Both international developed and emerging market stocks (in local currency and U.S. dollars) trailed domestic shares by a considerable margin as foreign investors sought safety and better returns in U.S. markets. The U.S. dollar strengthened versus most other currencies (over the full year) for similar reasons.

Tug of War 

COVID and inflation had the largest influence on the stock market last year. However, each impacted stocks in different ways. Small-capitalization value stocks benefited early in the year as the economy continued to normalize after the original 2020 COVID wave. The Delta and Omicron variants that materialized over the summer and holiday season (respectively), generally weighed on these same stocks as the year progressed. The emergence of inflation and its random flareups throughout the year seemed more positive for these companies as many were seen as being nimble and capable of adjusting to higher prices.

Conversely, larger capitalization, growth-oriented stocks outperformed as shares of technology and internet-related companies benefited from the continued COVID environment that extended remote interaction for commerce, work, and socialization. Many of these same stocks performed poorly as inflationary fears appeared sporadically throughout the year. It is generally believed that the high interest rates that often accompany inflation also lowers the value of companies and their stocks. Growth and technology stocks, in particular, are thought to be more adversely affected by rising interest rates as a large amount of their net worth is derived from high expectations of future growth.

The Year Ahead 

Despite the difficulties of 2021, we are encouraged by how the year ended and by what 2022 may bring. Although we do not make forecasts or prognostications about the future (we typically consider this low-probability speculation), we do believe COVID and inflation are factors that will remain front and center in 2022. We also expect interest rates to rise during the year as the Federal Reserve increases its guard against inflation. Additionally, we can never discount other issues which may choose to assert themselves throughout the year (China, Russia, or perhaps something unknown to us at this time). This noise, no doubt, will create some stock market dislocations and inefficiencies (i.e., volatility). As always, existing correlations between stocks and these factors may or may stay constant.

Given these potential disturbances, one may think we have our work cut out for us. However, we would not want it any other way! Recall, our investment strategy takes advantage of opportunities that generally occur when the stock market is volatile. We believe that volatility is a sign of stock market inefficiency that can be exploited over the long term. Taking advantage of these opportunities can allow us to add value for our clients and, in turn, help them to reach their long-term goals. As such, we are hopeful that 2022 will prove friendly towards active and value investors generally and our investment strategy, in particular. We wish you the best in the new year to come.