Stableford Capital—December 2021 Review: All is not as it seems.
After a tumultuous month, the S&P 500 finished December up 4.4%.
Equities Rebound in December
But the headline returns don’t tell the whole story. Beneath the surface of the headlines much is changing. The leading sectors of the market have turned defensive, in contrast to much of 2021.
As Exhibit 2 shows, during the last one and one-half months of 2021 the top returning sectors of the S&P 500 leaned heavily defensive: real estate, utilities, healthcare and staples. This makes sense, as investors anticipate the next phase of the cycle during which the Fed raises rates, cyclical leadership fades and valuations shrink.
Defensive Rotation Under the Index Headline Return
Furthermore, history tells us that as the Purchasing Manager’s Index (PMI) begins to fall from a high, we have likely passed the peak of the business cycle (Exhibit 3). Equity returns tend to skew more defensive from here (Exhibit 4).
Deceleration in PMI Indicates Business Cycle Has Peaked…
…After Which Equity Returns Typically Skew More Defensive
Interestingly, Info-Tech remained relatively strong at the end of 2021 as well. But this seemed to us like investors “parking” their funds for the end of the year, unwilling to make new bets prior to the calendar turn. With valuations high and large cap tech a substantial portion of the index weight, this should prove a headwind to headline index gains in early 2022.
Interest rates began to move up in December after the Fed’s more hawkish pivot. Yields on the U.S. Treasury 10 Year note rose 6.5 basis points to 1.51% (Exhibit 5).
Nominal Rates Increase in December
Now that we are clearly on a rate-hike cycle the risk of the Fed moving rates up too quickly in the short term are elevated. We expect volatility will be elevated during this period. However, in the medium term, we’re sanguine on equities. The economy remains robust due to the previous rounds of stimulus spending, consumer balance sheets remain strong and higher wages are aiding continued spending.
There is a delicate balance to this though. Inflation will need to decelerate soon. This should happen in the next 2-3 months. Wages will also need to remain reasonable. If this occurs the Fed doesn’t have to move as quickly and risk breaking something. So, despite all the risks, the Goldilocks scenario of decelerating inflation and wage growth with a robust consumer spending remains a reasonable outcome.
At Stableford we moved to a more defensive posture within equities towards the end of 2021, increasing holdings of defensive sectors such as real estate, healthcare, and staples. Within fixed income, we continue to favor variable rate securities that are less likely to lose value as rates increase.
Are you interested in making portfolio changes or getting a more in-depth analysis? Contact Stableford today by calling 480.493.2300 or simply request a copy of our Market Blast.
This market commentary was written and produced by Stableford Capital, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 INDEX: The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.