The fourth quarter of 2021 was another positive time for US stock markets. This brought year-end performance well above historic averages. Developed International stocks advanced also, though to a lesser degree. Bond markets struggled again at the end of the year, with the commonly quoted Aggregate Bond Index falling in value.
Inﬂation became meaningful for the ﬁrst time in a few decades. The unprecedented levels of stimulus pumped into the economy over the previous two years has been spent faster in 2021. When this excess money went searching for goods constrained by supply chain disruptions, inﬂation became inevitable. It now appears that it could last longer than just a blip in the chart.
The economy has been growing well below longer-term inﬂation rates, typically considered healthy in the 3% area. The government has only been publicly targeting 2% inﬂation over the previous years, while regularly falling short. Therefore, an inﬂation rate of 4-5% would only be catching us up to the longer-term trend.
None of this has caught us oﬀ guard. Managed portfolios take many types of risk into account, with inﬂation being one of them.
The positive return in stocks was not a smooth ride. Volatility reared its head more than once. To the side you can see that only 57% of the individual days saw positive performance in the S&P 500. Interestingly though, that is completely unremarkable. In fact, over the last 70 years, the S&P 500 is only positive 54% of the days. This serves as a great reminder of the benefits of being patient investors. A down day, week, month, or even year is completely normal. It is even common to see a 10% or greater fall in stocks during years that have positive returns.
Bonds were not the beneﬁciaries of the above developments. Receiving 2% interest is not very attractive if your spending power depreciates at an inﬂation rate of 5%. Aggregate and Investment Grade Corporate Bonds each depreciated a percent and a half during the year. Municipal bonds ﬁnished in the black, on the suspicion of increasing taxes for wealthy individuals.
This does not completely diminish the value of owning bonds. While it does make them less attractive for longer term needs, inﬂation is unlikely to plummet their value in short-order. In fact, government bonds have been one of the best performers in bouts of stock market volatility, reminding us of the value of diversiﬁcation. They can play a valuable role, especially for those that are currently, or soon to be spending, their investment savings.