Despite supply chain constraints, the rapidly spreading Omicron variant and rising fears of inflation mixed with tightening monetary policies, the MSCI All Country World Index, a broad measure of global equity markets, rose close to 7% during the fourth quarter of 2021.
Daily COVID-19 cases accelerated dramatically during the festive season as global daily cases amounted to nearly to 2 million prior to New Year’s Eve celebrations. In particular, the surging Omicron variant has spread rapidly across the US and Europe as daily cases continue to set new records. One might have assumed this would have given investors cause for concern but what may have soothed fears is that the daily death rate has not risen and has remained fairly stable. In addition, recent findings appear to show that vaccines from companies such as Moderna, Johnson & Johnson as well as Pfizer appear to be effective against the Omicron variant.
Across the globe, inflation continued to escalate during the quarter. In the US, consumer prices rose a little under 7% during November, the largest increase in nearly four decades. Eurozone inflation rose to just under 5%, a level not seen since the creation of the Euro. South Africa has also experienced its own increase in inflation with the most recent increase of 5.5%, the highest since 2017. In a bid to curb rapidly rising prices, central banks have begun to withdraw monetary support with particular emphasis on interest rate hikes. The US Federal Reserve (“Fed”) has pivoted towards a more hawkish (concern over inflation) stance as it has brought forward its projection to raise interest rates. The Bank of England has commenced its process as it increased the UK base rate by 15 basis points to 0.25%. The European Central Bank has somewhat bucked the trend by ruling out rate hikes during 2022 but the South African Reserve Bank has not. The South African repo rate was raised during November by 25 basis points to 3.75% and it is possible that South Africans could see a series of rate hikes during 2022.
Covid concerns and the withdrawal of monetary support aside, with the exception of the Communication Services sector, global equities delivered positive returns during the fourth quarter of 2021. Though gains for global equities were broad-based there was one sector in particular that stood out for its strong performance, namely the Information Technology sector, as it returned over 12% during the quarter. Drilling down further into the sector shows that the companies that significantly contributed to the sector’s outperformance were those associated with semiconductors as well as technology hardware, specifically iPhone maker Apple which briefly became the first company to ever have its market cap exceed $3 trillion – roughly eight times larger than South Africa’s GDP.
The Information Technology sector is by far the largest in the US and therefore was a significant contributor to the performance of the S&P500 Index, a broad measure of US equity markets, which returned 11% during the quarter. One factor that may be driving the US market and more specifically the Information Technology sector or at least supporting the elevated valuations of such stocks could be the level of interest rates. As mentioned, the Fed along with other central banks have begun, or at least signalled their intent, to tighten monetary policy and raise interest rates. It could be assumed that increasing interest rates would be negative for Information Technology stocks, more so than other sectors, as on a relative basis they are more negatively correlated to increasing rates, specifically longer-term rates.
Despite the Fed signalling an acceleration on rate hikes in a bid to curb rampant inflation, yields on longer-term US treasuries ended the year close to zero as the benchmark 10-year Treasury rose only one basis point during the quarter to end at 1.51%. What is quite interesting is that despite US inflation increasing to its highest level in decades, the longer-term inflation outlook, at least according to the bond market, appears more muted as the US 10-Year Breakeven Inflation rate only rose 19 basis points during the quarter to end at 2.56% suggesting higher albeit lower than current levels of inflation in the future. The moderate rise in inflation expectations coupled with a flat 10-year Treasury yield (nominal) meant that the real yield (the yield after stripping out inflation) on the 10-year US Treasuries benchmark fell further below zero, closing the quarter at negative 1.0%. The combination of the aforementioned could suggest that the bond market, at least for now, is not expecting significant interest rate increases nor is it expecting the elevated levels of inflation to persist. Negative and increasingly negative real yields are positive for equities especially for those whose value lies further out in the future such as tech stocks. Of course the opposite would apply if we were to see a rise in longer-term rates, especially real yields.
One nuance to the interest rate story currently unfolding is how it is impacting the Financials sector, specifically banking stocks whose profits are a function of the spread between short-term and long-term interest rates. Whilst banking counters were able to deliver a positive performance for the quarter, they underperformed the broader market as longer-term rates still remain depressed despite the prospect of sooner-than-expected rate hikes.
Another sector that gained during the quarter but still underperformed the global equity market average was the Energy sector, returning a little under 4% during the quarter. The price of Brent crude endured a volatile final quarter of 2021 having first fallen over fears related to the threat of rising COVID-19 cases and the ramifications on fuel demand resulting from travel restrictions. Demand concerns were however somewhat allayed as the expected impact of the Omicron variant may not be as severe as originally anticipated. As a result, the price of Brent crude experienced a roller coaster ride during the quarter before ending flat at $78 a barrel.
Although European equity markets trailed the performance of US markets, they still managed to deliver positive returns for the quarter as the Euro STOXX 50 Index and the FTSE 100 Index, broad measures of European and UK equity markets, returned 6% and 5% respectively in local currency terms (in USD terms their respective returns were 4% and 5%). Much of their relative underperformance for the quarter can be ascribed to their underweighting of Information Technology stocks as well as the imposition of stricter lockdowns in the region which elicited a negative reaction from concerned investors.
Asian equity markets lagged during the quarter as Japan’s TOPIX Index and Hong Kong’s Hang Seng Index declined 2% and 5% respectively. The SSE Composite Index, a measure of all stocks traded on the Shanghai Stock Exchange gained 2% during the quarter but still trailed global equity counterparts. The regulatory crackdown by Chinese authorities continues to weigh down Chinese equity markets especially large tech Chinese stocks with US listings such as Alibaba and Tencent. In addition, concern has begun to grow over the possible delisting of these Chinese equities from US exchanges following the news that Didi, China’s version of ride-hailing company Uber, will delist from the New York Stock Exchange – a move that could be repeated by other US-listed Chinese stocks.
South African equities outperformed global markets during the final quarter with the JSE All Share Index returning close to 15% (9% when converted into USD). The strong relative outperformance was however not completely broad-based and can be laid at the doorstep of a handful of counters beginning with Richemont which gained over 50% during the quarter following a sold set of results that came in ahead of expectations. Additional contributions to the positive performance included resource stocks, following strong gains from both diversified miners such as BHP and Anglo American as well as precious metal counters with the JSE Precious Metals and Mining Index gaining over 30% during the quarter. Base metal prices strengthened during the quarter as we saw gains in the price of Copper (+7%), Nickel (+15%), Tin (+8%) and Zinc (+20%) though there was a slight decline in Aluminium (-2%). Precious metal price movements were not as notable as prices for Platinum (0%), Palladium (-1%) and Rhodium (+3%) were fairly muted during the quarter and gold climbed a modest 4% during the period.
It has been somewhat of a strange year for gold. Given the amount of debt currently sitting on the balance sheets of central banks as well as the surge in inflation, one might have expected more investors to flock towards gold as a store-of-value safe haven. However, the yellow metal appears to have lost some of its shine among investors having closed the year at a $1,807/ozt, a level slightly below that where it began 2021.
Many have suggested that gold has been replaced by a digital version thereof, namely cryptocurrencies. The most popular of the digital assets is Bitcoin which outperformed gold during the quarter having gained over 5% to end the year just under $47,000. It was however a volatile quarter for Bitcoin having peaked at just under $68,000 during November only to experience a precipitous fall for the remainder of the period.