Shares in Australia were led higher by its mining juggernauts, BHP and Fortescue, as iron ore prices finally rebounded following four months of steady decline. Global developed regions were also spurred on by strong economic data, most notably the lowest jobless claims recorded in the US for over 50 years. As was the trend throughout 2021, Emerging Markets underperformed the rest of the world as sweeping regulation in China continues to weigh down the performance of local businesses. Global Bonds also finished the year in negative territory as lingering inflation concerns saw bond yields rise and prices fall.
The year in review
2021 was, once again, dominated by COVID related headlines as economies ramped up their vaccination rates in a quest to shift towards a ‘living with COVID’ stance. However, new variants of the virus complicated this transition, with the latest variant, Omicron, driving case numbers to new highs globally. Although its symptoms appear milder than the Delta variant, Omicron has proven far more transmissible, with one case sparking at least three other new infections on average. As has been the case since the outset of the pandemic, the biggest risk facing markets is that the surge in cases will generate overwhelming pressure on health systems, leading to further lockdowns and contractions in economic activity.
Inflation was the other major theme in 2021, as supply shortages resulting from COVID disruptions were met with increasing consumer demand following a tsunami of fiscal and monetary stimulus. This drew our attention toward the guidance provided by central banks regarding the timing of expected interest rate hikes. While we didn’t see any official cash rate rises in 2021, we did see markets bring forward their expectations of when they may commence, which affected the performance of certain asset classes, such as bonds.
Value companies well placed to shine in 2022
Inflationary pressures are expected to remain in the first half of 2022, particularly in the US where headline inflation has now risen to 6.8%. While prices in Australia haven’t accelerated as fast, we did see core inflation drift into the RBA’s target range of 2-3% for the first time in six years recently.
During inflationary periods there are certain sectors of the market that tend to outperform others as they are better able to absorb the impact of higher prices. For instance, the revenues of energy stocks are naturally tied to energy prices, a key component of inflation indices. So, by definition, they should perform well as inflation rises.
Additionally, banks can also be beneficiaries in environments where inflationary expectations drive rates and yields higher. Higher long-term rates will improve a bank’s net interest margin, which is a key driver in their profitability.
In recent times, we’ve seen a stark contrast between the performance of value companies, which are often heavily comprised of Energy and Financial companies and the rest of the share market.