Annual Review & Outlook - 4th Quarter - 2021

It has been EPIQ’s discipline to begin the new year with a review of the past while simultaneously sharing our expectations for the period ahead. With a global pandemic entering its third year, we have adjusted to a new reality, accepting the inescapable impact on lives, lifestyles, our society, and the economy. Fiscal 2022 is off to a challenging start as markets in the first weeks of the year continue correcting due to economic anxiety surrounding inflation. Government policies are at an inflection point and markets are pricing in change. The current situation therefore could offer an attractive investment opportunity when uncertainty dissipates.

 A Brief Review of 2021

By year-end, public market equities, domestic and abroad, delivered solid if uneven returns. US markets led the way, again outperforming global markets which closed 2021 with double-digit gains for the third year in a row. The largest US companies powered returns, evidenced by the Russell 3000 (the broadest measure of US listed companies) which returned 26% (on top of 21% in 2020). However, the Russell 2000 Growth Index (representing the 1000 smallest and fastest growing companies) returned just 3%; from February highs, the small cap index declined 11%.

In many cases, stock price declines belied fundamentals, as most companies met or exceeded expectations. In 2021, value stocks outperformed growth stocks for the first time in five years, heavily weighted to the second half of the year. Developed markets generally rewarded investors, while Emerging market returns, especially in China, fell precipitously as the Hang Seng declined more than 15% in US dollar terms.

Bond markets did not fare well with expectations for faster economic growth, rising inflation and changing policies weighing on returns. The Bloomberg Barclays US Aggregate Bond Index declined 1.5% over the past year. Emerging and Developed bonds did not perform any better. With lower credit quality and greater sensitivity to equity, Bloomberg’s US High Yield Index returned 5.3%, and the projected yield for this basket at year-end was just 4.2%. In this environment, we believe the index is misnamed since the yield is certainly not ‘high’ though the risk may be.

Using our rearview mirror, we must give a nod to inflation which began to accelerate in the second half of the year. The slow but steady rise was driven by the combination of fiscal stimulus initiated in 2020 to fight the pandemic, global supply chain woes, and reduced productivity—aligning perfectly with the traditional definition of “too much money chasing too few goods”. Labor initiatives have begun to further fuel the fire. The Consumer Price Index (CPI) rose 7% through December and 5.5% excluding food and fuel, the highest levels in nearly 40 years. While inflation, and the Fed’s stated policy to fight it, affects all markets, opinions differ as to whether this is transitory (i.e., we will revert to 2.5%) or long lasting.  

With inflation on the rise, commodities and other hard assets delivered another year of solid returns, though, like stocks, there was wide dispersion among subsectors. While energy rose substantially, gold declined. Within real estate, multi-family delivered for investors while exposure to healthcare, office and lodging did not.

EPIQ Musings

·        Transitions fuel uncertainty that in turn creates volatility. Unprecedented fiscal and monetary policy that supported markets in crisis the past two years has already begun to dissipate. Inevitably, this will drive capital flows from one asset class to another. Cash is moving from riskier assets to safer havens, defined as businesses with histories of steady, profitable growth. While the highest-rated bonds have also benefited from recent policies to support the economy, as the stimulus fades, the opportunity for bonds continues to retreat.

·        Workers and savers continue to see their purchasing power evaporate as inflation outpaces wage growth and nominal interest rates. The Fed has begun to tighten the money supply, thus removing one of the catalysts that led to our current inflation situation. We are confident in the Fed’s ability to execute, supporting full employment while reducing current inflation to an acceptable level, though it may take many months.

·        Investors are affecting positive change, in some ways filling the void left by a lack of leadership and consensus in Washington. Shareholders are using their collective weight to bring increased transparency and accountability to executive compensation, diversity and inclusion, and climate issues. This trend is exemplified by Engine One’s unusual success in taking on Exxon, lobbying shareholders to elect three new directors to Exxon’s board over the objections of management.

·        Workers are using their influence as well. ‘The great resignation’, corporate-instigated increases in minimum wages and substantial gains made in union-negotiated contracts all showcase the rising power of labor. The most cited example is the outcome of John Deere’s recent union negotiation (signing bonuses plus 10% wage increases this year, 20% over life of the contract). The markets are driving change where politicians are unable to find agreement. We see this movement continuing to gain momentum.

·        Savings rates have surged during the pandemic which has led to stronger consumer balance sheets. This is supporting demand and in turn, inflation. Companies, in general, have also fortified their balance sheets. This strength should provide a healthy construct to drive future productivity enhancements, a pillar that helps drive improvements in standards of living.

·        Our pandemic perspective continues to evolve, and we now believe that the SARs COVID-2 virus and its variants are with us indefinitely, meaning the pandemic will become endemic and will ebb and flow with the seasons. The good news is we are far better equipped to deal with it.

·        Areas of continued focus for EPIQ include inflation hedges (hard assets such as real estate); equity Income ideas (e.g., investments in the pharma, financial and industrial sectors); opportunities in electric vehicles, solar energy/infrastructure, and water; and means of applying technology to food/agriculture markets.

The investment landscape will continue to morph alongside our economy and society. As we solve one problem, another one will be uncovered. Locally and nationally, we are facing significant political, societal, and economic pressures. They may seem daunting, but we have always found a way to move forward, keeping alive the dream of improving prosperity for all.

Please contact us to continue the conversation. Wishing you a healthy and prosperous 2022!

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EPIQ Partners

Daniel Aronson, CFA                                                    Bruce Langer, CFA                                                         Ben Frey, CTP    

Rachael Scherer, CFA                                                   Julie Ellison                                                                     Noah Haverdink