We are happy to report that stock market returns were above the historical average for the third consecutive year. However, fixed income returns in 2021 were muted. Financial markets are discounting mechanisms, meaning that changes in investor expectations about the future either depress or elevate security prices. As such, one of the year’s most important milestones for financial markets was the fact that, to borrow Winston Churchill’s phrase, we reached “the end of beginning” in the war against Covid. Although the virus is still with us, the progress that the health care community has made in treating and preventing the disease has made it possible for investors to start looking beyond the pandemic as they evaluate the future. This progress had a positive impact on the stock market in 2021.
Partly offsetting the progress against Covid, a jump in inflation rates to levels not seen in 39 years has the market on edge. Inflation depresses stock and bond prices because it reduces a future cash flow stream’s buying power. As economies reopened, pent-up demand, fueled in part by fiscal and monetary stimulus, encountered a supply chain that was tied up in knots. The Wall Street Journal noted that it was a “…combination not seen, perhaps, since the aftermath of World War II.” This combination of strong demand and limited supply created inflationary pressures not seen in decades. Time will tell whether the supply chain bottlenecks can be removed and whether demand will return to more normal levels. Over the long term, we believe demographic trends and the deflationary forces unleashed by technology will keep inflation in check.
The market’s year end volatility coincided with a shift in the Federal Reserve’s monetary policy. To borrow another phrase from the same Churchill speech, we reached the “beginning of the end” of this cycle’s easy money policies. The Federal Reserve has supported the economy during the fight against Covid by keeping interest rates low and purchasing trillions of dollars of mortgages and government debt. In November the Fed announced that it would start removing its support, first by slowly reducing its mortgage and debt purchases. In December the Fed said that it would accelerate the reduction of its purchases, and that it expects to start raising interest rates in the first half of 2022.
This change in the Federal Reserve’s monetary policy away from an extremely accommodative position will be important. Higher interest rates will likely create headwinds for future investment results. Interest rates are the discounting mechanism used to value the future cash flow stream that a company or bond is expected to generate, and higher interest rates reduce the present value of future cash flows. Higher interest rates will also make it more difficult for the economy to grow. Given the increased likelihood of higher interest rates, we recommend planning for more muted investment returns than we have experienced these last few years.
Before concluding, we’d like to note that 2021 marked Gamble Jones’ 65th year in business. We have experienced many economic and investment cycles since our founding and our investment philosophy has proven its ability to generate attractive long-term results. That investment philosophy is based on the belief that buying companies with attractive returns on capital, healthy balance sheets, strong cash flow streams, good management teams, and attractive growth opportunities at reasonable prices will generate attractive long-term returns.
We wish you all the best in 2022 and look forward to working with you throughout the new year. Thank you for your continued trust.
Alison Gamble, President
Gamble Jones Capital Management