January 2022 near-term market assessment

January 2022

In summary, we have a neutral view across most major markets, but recently shifted to a positive bias in the broad real asset category given continued inflationary pressures related to the lingering pandemic. Due to likely tighter financial conditions going forward as policy rates rise and the potential for the continued recovery in the global economy putting additional upward pressure on interest rates, maintaining broad asset exposures close to benchmarks is likely appropriate.

However, at the asset class level, we recently shifted to a negative bias from neutral for cash/short-term government bonds given expectations that real rates will stay deeply negative despite policy tightening. We made a similar shift in view for emerging market debt in local currencies due to rising rates in the US and a stronger dollar.

Counter to that, we maintained our positive position in US equities and moved from a neutral to positive position in commodity futures. We consider that over the longer-term, interest rates are likely to remain at historically lower levels, and that the global economy will continue to recover (albeit likely with greater volatility) and be supportive of both asset classes. For equity style (value/growth), we maintain our neutral view despite value stocks notably outperforming growth equivalents largely because of investors shifting to companies expecting to weather the higher
interest rates.

In reviewing market developments, US equities (S&P 500) finished 2021 strongly, up 4.5% in December given declining fears related to the Omicron variant. This brought the calendar year results to +28.7%. Equity markets are off to a rocky start in 2022 though, given expectations for tighter monetary policy. Markets are currently pricing in roughly 115 basis points of tightening through the end of 2022 and, anecdotally, the FOMC to begin to draw down their balance sheet towards the end of the year. From a sector perspective, energy and financials led the way last year with the trend continuing this year due to strong commodity performance and higher interest rates. Most other sectors are lower year-to-date given the market sell-off.

International developed (MSCI EAFE) and emerging market (MSCI Emerging Markets) equities also rose in the last month of 2021 with international developed markets (+5.1%) outpacing US equities. Emerging markets lagged in December (+1.9%) driven by continued concerns related to China. Overall in 2021, international equity markets trailed US equities given continued pandemic struggles with weak results in China further weighing on emerging markets. So far this year, the trend has been the opposite though with international equities performing better than US equities given the impact of tighter policy expectations in the US. Positive year to date results in China have provided additional support for emerging markets.

In fixed income markets, expectations for less accommodative policy and rising inflation caused the broad bond market (Bloomberg Barclays Aggregate) to decline slightly (-0.3%) in December leading to calendar year results of -1.5%. Lower rates, continued strong corporate results, and the overall risk-on environment led to high yield bonds gaining 5.3% last year. This year increasing fears related to Fed tightening and persistent inflation, caused the 10-year US Treasury yield to trade at pandemic highs around 1.80%. Short-dated yields continue to increase while policy expectations solidify. The two-year Treasury recently breached 1.0% to trade at 1.18%, representing a 91 basis point increase since September 2021. From a duration position perspective, we have shifted to a preference for longer duration exposure versus shorter, given profound negative real rates and the potential for the recent increase in longer dated rates to be overdone. Nonetheless, corporate debt spreads across both investment grade and high yield remain at record tight levels to Treasury equivalents as investor demand for yield continues.

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