Year-End Wrapped: 5 Themes That Defined Markets in 2021, and Why They Are Here to Stay

December 30, 2021

3-5 minutes reading time

2021 was eventful, to say the least, perhaps seemingly more so than most years. Out of the hundreds of events that defined 2021, most of them will turn out to be nothing but media buzz and a mere blip in history. But each year, if we look close enough, emerges themes that will have profound impact on shaping the future direction of global financial markets. We have distilled them down to five key highlights below. We believe these themes will represent secular shifts in future capital allocation.

1. Rise of the retail investor

Never before in history has the retail investor had such an outsized impact on financial markets. According to the Financial Times, retail traders now make up almost a quarter of US stock market volume, a number that surpasses both mutual fund and hedge fund volumes.

The savviness of retail traders are often being questioned, and yet some managed to beat many institutional investors at their own game this year. Whether the industry likes it or not, retail investors are here to stay, and they’re changing up the game. 

While institutional investors rely on intrinsic-value financial models, retail investors often rely on trend-following momentum strategies. Institutional investors get their information from Bloomberg, while retail investors look to public forums such as r/wallstreetbets and Twitter. The stocks of interest widely differ as well, and has even led to bifurcating labels such as “meme stocks” vs. “boomer stocks”.

At the end of the day, who’s to say who’s right and who’s wrong? The industry needs to recognize that retail investors are a different force, driven by different motivations and objectives that could result in a different prospect utility curve. In fact, we welcome the growing presence of retail investors as market participants. Differing opinions can improve long-term market efficiency, and the financial empowerment of everyday people means that investment managers and wealth managers need to step up their game in terms of the products and services they offer. A boring old traditional balanced fund just won’t cut it anymore.

2. A monumental year for ESG

A record $649 billion poured into ESG-focused funds this year, putting global ESG investment assets at a record total of $30 trillion. Unfortunately, ESG’s mainstream movement also creates perverse opportunities for greenwashing, which is becoming increasingly problematic. Many so-called ESG funds in the market today actually make little or no impact on environmental, social, and governance issues. 

To combat greenwashing, policymakers made several big leaps this year - from the European Commission’s Sustainable Finance Disclosure Regulation, to the CFA Institute’s Global ESG Disclosure Standards for Investment Products, to here at home the IIROC issuing guidance on embedding ESG into KYC conversations.

2021 was also a landmark year for climate action. The UN Climate Change Conference (COP26) saw a global wave of net-zero pledges, but whether this is just virtue signalling or an impetus for real change - we’ll just have to see. 

In the meantime, investors have an opportunity to play their part by aligning their investments with climate change initiatives - but it’s not enough to just invest in any ESG fund. Most ESG funds in the market focus on exclusionary screens and ESG ratings, which are often backward looking and highly subjective. Instead, climate-aware investors should direct their efforts toward Impact Investing, which focuses on intentional and measurable positive change. 

And yes, we’ve even seen greenwashing around the “Impact” label as well. Make sure you can spot the difference! A conventional ESG fund may exclude a few controversial sectors while investing in companies that score “high” on their proprietary scoring methodology. An ESG fund that focuses on Impact Investing will be able to tell you “By investing $X dollars in this fund, you will help reduce XX tonnes of CO2e based on Scope 1, 2, and 3 measurements”. That’s real change.

3. Inflation hits multi-decade highs

As we noted in a previous article, there are several driving factors behind the inflation surge, some that could be transitory and some that could be persistent in nature. We’re not here to speculate between the former and the latter, as there are valid arguments on both sides. 

Instead, we find it concerning that the media has been mostly portraying this inflation surge in a negative light. If one only focuses on the higher prices paid by consumers - well of course no one likes to pay more. But when we consider the factors beyond just price inflation, things are actually not as bad as they seem.

Inflation is gauged by the Consumer Price Index (CPI), which tracks the price of a basket of goods and services. It does not, for example, take into account wage inflation, which trended well over 10% on a year-over-year basis over the last few months. People are paying higher prices, but they’re also getting paid more. 

The other thing to remember is that inflation is measured on a year-over-year basis. Even if prices had been stable over the last few months, the roll-forward effect from last year’s consecutive months of falling prices will result in a lower price base to calculate from. 

FInally, the assumed basket of goods and services tracked by CPI may not reflect people’s actual spending patterns, and it certainly does not incorporate last year’s price gains from real estate, which is owned by more than 60% of Canadian households. As for investment portfolios, our previous article highlights how inflation impacts the markets and what investors can do to mitigate the potential downside risks.

While we’re not downplaying the seriousness of the recent price pressures, we would deem it prudent to look at all sides of the equation.

4. Science fiction goes mainstream

Blockchain, crypto, NFTs, Web3… and now metaverse. What were once abstract internet concepts are now part of our daily media buzz. While we are long-term optimistic on all the ways these exponential technologies will transform society, we must also be mindful of the short-term risks. Hype leads to speculation, and the downside risks are high. 

That said, we do not believe investors should simply shy away. Bitcoin, often mocked by wall street incumbents, has garnered a market cap of $1 trillion, and has actually proven its positive contribution to risk-adjusted return when included in a traditional 60/40 portfolio. Whether you like it or not, and as volatile as they are, cryptocurrencies need to be recognized as an investable asset class.

We prefer to navigate this space with a “picks and shovels” mindset. While we do include cryptocurrencies in some of our higher risk model portfolios, we believe there are great opportunities in seeking exposure to companies that provide the digital infrastructure. Instead of YOLO-ing on a cartoon monkey JPEG, why not invest in the platform that facilitates these transactions?

5. Globalization and US dominance have peaked

Globalization brought the world together in culture, trade, and technology. However, events such as Brexit and the rise of protectionist ideologies have left us wondering if perhaps we’re past its peak.

Then came the pandemic. Recessions are typically highlighted by demand shocks as consumers and businesses pull back their spending. This time, we also saw a supply shock as social distancing measures meant manufacturing centers had to run on reduced capacity. The pandemic revealed the fragility of our supply chains. Just-in-time manufacturing, an approach used widely around the world, may now need to be reconsidered as the reliability of global supplier partners come into question. If multinational companies start to rethink totally outsourcing their manufacturing overseas and bring production home, it may create further inflationary and wage pressures.

While we may not see the Trump-era level of trade war spats going forward, US-China tensions are here to stay. At the root of the conflict is a fundamental difference in ideologies between two superpowers that inevitably spills over into economic and technology realms (think disputes over 5G, Chinese company delistings on US exchanges etc). Of course neither side is going to back down, so it will be interesting to see over the coming years how each nation grows and maintains their spheres of influence. 

Historically, emerging markets have been mostly a source of cheap manufacturing. Today, with the growing middle class in Brazil, China, and India, a slew of companies have emerged to serve their domestic markets, powered by home-grown innovation. In fact, emerging markets now account for 75% of global GDP growth and yet only represent around 12% of a global equity index, meaning investment portfolios are generally vastly underweight emerging markets. Most balanced funds in the market have either too high of a Canadian home-country bias, or are too US-centric. Think global, or else you’re missing out.

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