Year two of the COVID-19 pandemic proved to be a banner one for equity markets, as fiscal and monetary stimulus combined with successful vaccine introductions and strong economic growth pushed corporate earnings up to record levels. While the late-year emergence of the Omicron variant spooked the market post-Thanksgiving, those concerns abated and the market once again advanced to record highs late in the quarter.
The U.S. stock market, as measured by the S&P 500 Index, posted its best quarter of the year, advancing 11.0%, capping off an impressive full-year gain of 28.7%. Nearly all sectors showed positive returns in the quarter, led by the bond-proxy Real Estate sector and the mega-cap heavy Information Technology sector which both climbed by over 16%. Communication Services and Financials lagged in the quarter, as large media and entertainment stocks and banks struggled. Full-year returns were led by Energy, riding the 50% gain in crude oil prices, and Real Estate, whose high yields proved attractive to income-oriented investors. More defensive Utilities and Consumer Staples sectors lagged, as they often do in a bull market, as did Industrials, which suffered from supply-chain constraints and inflationary pressures.
Small cap stocks as measured by the Russell 2000 Index posted positive, but more modest gains of 2.1% in the quarter and 14.8% for the year. Unlike large caps, which posted more consistent gains all year, smaller caps peaked in March and then went sideways for the remainder of the year. The Communication Services and Health Care sectors dropped about -10% in the quarter, reflecting the less speculative nature of the quarter’s returns as evidenced by large declines in meme stock AMC Entertainment and in the Biopharma industry. More defensive sectors, Utilities and Real estate posted double-digit gains. For the full year, Biopharma’s mid-20% drop gave Health Care the distinction of being the only sector to post a decline for the year. In fact, its -16% decline was 30% worse than the next closest sector. Energy led the way for the year, up over 67%, as the less seasoned small cap companies in this sector continued to post a substantial turnaround from last year’s near-death experience.
Large cap’s strong fourth quarter further extended its lead over small caps, as the quarter’s 8.9% relative performance extended the full year advantage to 13.9%. This relative strength can be attributed to the exceptional performance of the mega-cap names in the Information Technology and Consumer Discretionary sectors, as well as extreme weakness among small cap non-earners, especially Biopharma and Software names.
Among large cap stocks, Growth was clearly in favor in the quarter, driven by broad strength in the Information Technology sector. This surge pushed Growth ahead of Value for the year as well, although the modest two point spread was tempered somewhat by strong performance in the value-oriented Financials sector. Small cap leadership was just the opposite, as the disastrous performance by growth stocks in the Health Care sector explains most of Growth’s underperformance versus Value in both the quarter and the year. In fact, small cap Value’s 25% performance advantage over Growth was its largest since the Internet bubble burst in 2000.
We remain generally positive in our outlook toward equities entering 2022. This is not to say there are not risks. The Omicron variant clearly creates threats, especially to consumer demand and in supply-chain disruption. But thankfully the evidence points to a less dangerous, albeit highly contagious, variant that may very well be peaking out in the next few weeks. While not likely to be resolved immediately, supply-chain disruption should slowly but surely dissipate as the year progresses. Fed tapering is also cited as a risk to the 2022 outlook, as interest rates will likely climb and demand for risk assets may fall as accommodative monetary policies of the past two years are reversed. However, the strength of the economy should be sufficient to overcome these pressures. Favorable wage and unemployment statistics, strong housing prices and demand, solid Consumer spending and expansionary ISM Manufacturing and Services surveys, to name but a few, all still point to sustained economic growth. Lastly, inflation is proving to be less transient than initially expected. Indeed, inflation rates are hitting multi-decade highs. Certain components of inflation such as wage rates and housing do feel more persistent, although other components of inflation should be tempered by the easing of supply-chain constraints.