What will it take to kill this bull market? We will find out next year.

The insurgency, infections and inflation are what will be remembered for 2021. But none of them seemed to matter to US equities, at least as much as some might have thought. Again, the best thing for investors to do would have been to turn off their computers, phones and (especially) televisions, and set up and forget about their wallets.

The Stock Exchange would have amply rewarded those who turned a blind eye and who rolled the year in the indices of large caps. For this they would have been rewarded with a total return of 25.52% in the


SPDR S&P 500

exchange-traded funds (ticker: SPY) from early 2021 to Wednesday, according to Morningstar. (We’ll be looking at ETF returns since that’s how most people play at home.)

Getting out of the benchmark large cap index was generally not worth the risk or the effort. Small caps followed with less than half the return of their big brothers, with a cumulative return of 12.34% on the


iShares Russell 2000

ETF (IWM). Venturing abroad didn’t pay off either, with the


Vanguard FTSE All-World outside the United States

ETF (VEU) returning only 6.32%. Credit (or blame) less developed markets; the


iShares MSCI Emerging Markets

ETF (EEM) posted a negative return of 4.87%, and the


iShares MSCI China

ETF (MCHI) took a 22.02% hit.

The bonds did not pay off with the


iShares Core US Aggregate Bond

The ETF (AGG) has posted a negative return of 1.63% year-to-date, although the


iShares iBoxx $ High Yield Corporate Bond

ETF (HYG) managed a positive growth of 3.35%. But our income investment choice for 2021, closed leveraged loan funds, has almost kept pace with stocks. For example, a fund, the


Nuveen Variable Rate Income Opportunity

(JRO), returned 23.34%, with less risk than stocks.

Inflation, like Hemingway’s famous bankruptcy observation, started the year gradually and came suddenly. As 2021 approached, consumer prices were only increasing at a rate of 1.4% year-on-year, the result of deflation triggered by collapsing prices as the economy collapsed after the Covid-19 onset earlier in 2020, and well below the Federal Reserve’s Long-Term Target level of 2%. In January, Peter Boockvar, chief investment officer at Bleakley Advisory Group, in Lynx Eyes, began to warn of tightening supply that pushes up the prices of a wide range of products, from raw materials to DRAM chips. .

In the fall, supply chain issues were all over the evening news, with the weakest links appearing to be in ports where piles of containers with imported goods were waiting to be loaded onto trucks, which , with the drivers, were rare. And inflation was skyrocketing at a rate not seen in a generation, with the Consumer Price Index up 6.8% from the previous year, the fastest since 1982.

The narrowness of supply was only part of the problem. Another tax package totaling $ 1.9 trillion from the new Biden administration – in addition to the $ 900 billion package and the $ 2.1 trillion Cares Act passed the previous year – was being pumped into the American economy. More importantly, the Fed was supporting budget borrowing by purchasing Treasury securities at an annual rate of nearly $ 1,000 billion, as well as nearly $ 500 billion in agency mortgage-backed securities to help boost the economy. lodging.

All in all, James Paulsen, the Leuthold Group’s chief investment strategist, observed in January that money supply growth was four times faster and the federal deficit was four times larger than the last time the market was work was at a similar level. It all amounted to “too much cowbell”, as in the classic Saturday Night Live sketch, which foreshadowed much higher inflation.

Where the resulting inflation has manifested itself, but is not directly reflected in the price indices, is in housing. Earlier this year, Fed Chairman Jerome Powell called the new double-digit house price spike a pandemic-linked ‘transient phenomenon’ sending young families fleeing city apartments for single-family homes. with enough space to work from home.

In September, however, house prices were skyrocketing at a rate of nearly 20%, according to the most recent reading of the CoreLogic Case-Shiller Indexes. But, as former AllianceBernstein chief economist Joseph Carson pointed out late last month, homeowners’ equivalent rent (the convoluted way housing costs are counted in the CPI) has increased by less. by 3% compared to a year ago.

There is typically a six to 12-month lag before this rent metric catches up with soaring house prices, he observed. By then, he added, homeowners’ shelter costs, which account for nearly a quarter of the overall CPI, will increase retail prices far more than the widely seen surge in car prices. occasion last spring.

House prices weren’t the only thing to explode. The year that comes to an end will be remembered for the manic speculation about what has been called the memes stocks touted on websites like Reddit. As sports betting is reduced by the coronavirus, punters have turned their bets to companies that stand out mainly through bets placed against them. And with “stimuli,” Uncle Sam’s stimulus checks, free phone trading apps, and excess free time, these self-proclaimed “monkeys” have sought to take on the big and bad short sellers.

Whatever the motivation of the sans-culotte speculators, the source of much of their stake is the US Treasury, which has borrowed money at the lowest interest rates in history as a result of the bank. central American setting the cost of money at zero. . In real terms, that is, after removing inflation, it is well below zero, below negative 1% for 10 years.

It is an axiom of finance that a low cost of money increases the value of assets. The present value of the future cash flows of an investment increases as the interest rate to finance that investment decreases. Cheap and abundant capital can justify all kinds of wild and wonderful investments, from electric vehicles to stationary bikes with tablets connected to cryptocurrencies with no intrinsic value that can fluctuate by 20% over the course of a weekend.

Besides the seemingly endless effects of the pandemic, the hallmark of financial markets in 2021 has been the power of money, invoked and created by central banks. It has welcomed government borrowing on a scale never seen in peacetime and has inflated asset values ​​to record highs. And it has the same effect on the prices of what is bought, which has placed inflation high on the list of concerns of the public and politicians.

Next year, part of that process will start to reverse. Printing less money can slow down the process of increasing prices, but the impact is likely to be uneven. This may very well affect the prices of securities first, then the prices of goods and services. And the descent may be less pleasant than the climb.

Read more From top to bottom of Wall Street:Omicron is booming. Inflation is on the rise. But investors dream of a gathering of Santa Claus

Write to Randall W. Forsyth at randall.forsyth@barrons.com


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