The year 2021 was a good year for stocks of all types—value stocks, growth stocks, small-cap stocks, foreign stocks. As investors looked beyond the rise of two COVID-19 variants, Delta and Omicron, stocks finished the year at or near all-time highs. Investors also ignored a possible government shutdown, as well as concerns about a default on government debt.
As we entered 2021, it was supposed to be the year we returned to a new normal. With promising vaccines on the way and the economy recovering, many were expecting a strong economy and strong returns from the stock markets. Surprisingly, as new COVID cases rose sharply due to the emergence of the Delta variant in the summer, stock investors were mostly unfazed. Below the surface, however, we began to notice a bifurcation in the market. Foreign stocks and smaller companies began to stall out, even as the mega-cap technology leaders that we all know (such as Apple, Amazon, Google, and Microsoft) continued to move ahead. (Notice the gap in performance from the S&P 500 return versus the Dow Jones Industrial Average or small-cap stocks or foreign stocks in the table below.)
In the fourth quarter, even though the highly contagious Omicron variant spread, stocks continued to gain, finishing the year with double-digit returns. This was the third year in a row of double-digit stock returns, the strongest showing by the S&P 500 since the technology bubble in the late nineties.
It was a more challenging year for bonds overall. As interest rates rose in the early part of the year, all bonds that tend to move opposite the direction of interest rates (high quality corporate bonds and government bonds) sank. Bonds less influenced by changes in interest rates (high yield, floating rate, and mortgage-backed bonds) managed to post positive, though muted, gains for the year.
Outlook for 2022
FSA portfolios carried very little cash throughout most of 2021. As a result, they benefited from the stock market rally. At the start of the new year, all strategies are at or near all-time highs. While we are pleased, of course, that the portfolios grew nicely last year, it is our goal to preserve as much of those gains as is prudent. We always look at markets from the lens of potential risks that could be below the surface.
From a technical standpoint, it’s difficult to be too negative as we head into 2022. Broader market trends remain positive, although we could quibble with the leadership being among the mega-cap generals rather than seeing the preferred leadership from the troops (mid-cap and small-cap names). And it would be constructive if there was broader strength from a global standpoint. The U.S. market continues to be one of the best markets in the world.
The active rotation between growth and value stocks, or among the various sector funds, made it a challenge for managers to capture the periods of outperformance. Nevertheless, anytime there is a 30% spread between the weakest sector and the strongest sector, we want to be able to take advantage of those opportunities, even if it is difficult.
So, while it looks like clear sailing right now, there are a few issues that could spook investors as the year progresses:
- Rising inflation: If the current rise in inflation is not temporary (transitory), it will affect consumer spending and increase costs for businesses.
- Rising interest rates: The Federal Reserve has signaled it will likely increase rates this year which could be a damper on the higher growth technology companies that make up a big component of indices like the S&P 500 index.
- Results of mid-term elections: The stock market has tended to struggle recently during mid-term election years in response to the uncertainty created when the party in power loses control.
For the past two years, the stock market has seemingly ignored (or more aptly, seen beyond) the rise and fall of COVID cases, due in part to the massive injection of liquidity by the Federal Reserve, as well as the U.S. government, in response to the pandemic and subsequent lockdowns. As that liquidity becomes more fully absorbed into the economy, we may find the path for stocks gets more difficult this year.
So, even though we have had three strong years of stock market returns, we are not getting complacent at FSA. The stronger the returns in a bull market, the greater the amount of pain in the ensuing bear market. It is our goal (and we have nearly 40 years of experience in doing so) to manage the portfolios so that you reach your financial goals, while allowing you to rest easily at night.
Portfolio Update
Keep in mind that because we manage clients’ portfolios individually, the holdings in your particular accounts may differ somewhat from the averages.
Income (Strategy 1)
The year 2021 was a relatively good year for this fixed income strategy. While trading was light because we were content with the holdings (mainly high yield and mortgage funds), we expect that to change in 2022 if interest rates continue to rise.
Income & Growth (Strategy 2)
With a maximum allocation to equities of 50%, this strategy managed to post solid results for 2021, even though bond returns were anemic for the most part. We are very sensitive to volatility in this strategy and are quick to defend the portfolios if stocks weaken; therefore, it is a good place for clients who want consistent gains but are very sensitive to losses. Currently, these portfolios hold 45% in equities, 45% in bonds, and roughly 10% in money markets.
Conservative Growth (Strategy 3)
The portfolios in this, our flagship strategy, posted a good year. Trading was light in the fourth quarter, though in the taxable accounts we sold an international fund to recognize a loss for tax purposes. At the beginning of the fourth quarter, these portfolios held 70% in equities, 20% in bond funds, and 10% in money markets.
Core Equity (Strategy 4)
Stocks posted a third year of double-digit gains, which provided a nice tailwind for this equity strategy. Trading was light in the fourth quarter, but we did sell the health care fund and put those proceeds in an aggressive U.S. equity fund. Overall, the portfolios include both value and growth funds, with a modest tilt towards growth funds.
Tactical Growth (Strategy 5)
Trading remained fairly active in the fourth quarter as strength shifted to growth and back to value within the quarter. During the quarter, we reduced the international and commodity funds, while adding to broader equity funds. Coming into the new year, these portfolios hold 85% in U.S. equities, 5% in foreign funds, and 10% in money markets.
Sector Rotation (Strategy 6)
Despite the challenges from the active rotation among sector leadership this year, this strategy managed to post decent results. For January, these portfolios hold a mix of sectors, including transportation, semiconductors, industrials, basic materials, real estate, and consumer staples funds.
Finally, please remember to inform your advisor of any changes in your life that could affect your investment objective and how we manage your money.
Ronald Rough, CFA
Chief Investment Officer
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FSA’s current written Disclosure Brochure and Privacy Notice discussing our current advisory services and fees is also available at https://fsainvest.com/disclosures/ or by calling 301-949-7300.
