Firstly, before we review the last month of 2021, we hope you managed to get a welcome and enjoyable break over the Christmas period; we wish you a happy, healthy and prosperous 2022.
Higher reported inflation numbers gave central banks the excuse they needed to move towards ‘normalising’ monetary policy. The Bank of England surprised markets by increasing base rates from 0.10% to 0.25%, a modest increase to still extremely low rates but a statement of intent, nonetheless. The US Federal Reserve chose to accelerate the pace of its wind-down of quantitative easing (QE), pencilling in official interest rate increases for 2022.
One of the contributors to higher inflation in many countries, supply shortages, showed signs of abating in December but energy prices continued their impact on higher inflation. While energy prices might also be expected to moderate in the months ahead, labour tightness and skill shortages, resulting in higher wage pressures, look set to be a feature of 2022. This will continue to impact the margins of labour-intensive businesses.
While December, at times, felt like a turbulent market environment accentuated by daily updates on the spread of the Omicron variant of Covid-19, volatility as measured by the VIX index, fell over the month. Thinner, less liquid markets towards the end of the month, exacerbated moves in financial markets.
Bond yields moved higher and the US dollar weakened during the latter stages of December, leaving sterling higher than its US counterpart over the month. Cryptocurrencies endured a tough month, selling off against all developed market currencies with Bitcoin over 20% lower against the US dollar in December.
Government bond markets were softer in the second half of the month, notably ten-year UK gilts yields (as seen by the following chart from FT.com) rising from a mid-month-low of 0.70% to almost 1.00% at month end, equivalent to a 2.9% price drop.
Ten-year gilt yields in December 2021. Source: FT.com
Yields also rose in short and longer-dated maturities in the US over the second half of December. Perceptions of tighter and earlier than expected monetary tightness having their impact.
Oil had a strong month boosted by supply concerns and lower inventories. Metals, from gold to industrials also performed well, industrials aided by economic prospects increasing demand in 2022.
Against the above backdrop, it was perhaps surprising to see stock markets end 2021 so positively. December saw most major developed equity market indices in positive territory led by the Euro Stoxx index, followed by the US S&P 500. The exception was Japan, which was slightly in the red for the month.
Equity markets may have been looking past the rapid transmission and rising infections from Omicron and may indeed be viewing it as a faster route to herd-like immunity when coupled with rising booster vaccinations in the months ahead. While labour market tightness and its impact on wages will be a headwind for lower inflation, supply shortages of materials and energy prices are either abating or should do as 2022 develops. Although bond markets have cheapened in the latter stages of December, they remain an unattractive investment for investors seeking an above-inflation outcome. Equity markets should favour businesses with sustainable margins, able to pass-on higher costs, low-debt levels and not reliant on cheap labour. Keeping an eye on varying measures of valuation will be an important tool for investors.