The year 2021 transpired much as what we expected. Most stocks did extremely well, with the S&P 500 surging 27% for the year, marking the third consecutive year of gains over 18%. In comparison, bonds performed poorly, with long-term treasuries actually declining over 4% for the year with most bonds categories losing principal with the exception of municipals and the high yield or junk bond arena, which showed modest positive returns. These macro results corresponded with our dynamic pivot over the past two years to own real assets and to avoid (or minimize exposure) to bonds, particularly those long-term fixed income type investments. Investors that continued with a 60:40 stocks to bonds allocation were once again disappointed with the bond component. More importantly, as interest rates rise the negative impact on bonds will only become more significant. The other side of the investment equation is what to do with the fixed income component of the asset class that would still present the diversity away from stocks. For that part of this asset allocation, we continue to feel real assets provide an excellent alternative, not only for the higher income component, but also for the inflation hedge aspect.
Two years ago, we stated actual inflation was not being reported correctly by the government because of changes made in eliminating energy and housing from the index. At the time inflation was not on investors’ radar and clean energy advocates pressured natural gas prices to under $2MBtu for the first time since 1999 with investors writing off any future in fossil fuels. Combine that with the pandemic softening many real estate valuations, particularly in the commercial sector, and it is easy to see why select real assets present attractive total return potential versus bonds. This is particularly the case when investors factor in both the rising interest rate and inflationary environment… which in 2021 finally hit investors’ radar.
Just like with any investment the valuation, or price one pays, is critical. Also avoiding certain areas is important to navigate risk while enhancing long-term results. Sometimes it is the mistakes you avoid that become a key ingredient to success, like avoiding natural gas ten years ago when it was so popular or avoiding the general office category in real estate due to its high risk/low return nature, similar to long-term bonds currently.
Over the next several years there has never been a more crucial time to own the right assets and not adhere to conventional investing methodology. Just like bonds will be vulnerable to higher risk (for their paltry yield) than the average investor realizes, we believe the days of solid double digit percentage returns in stocks are numbered. While select stocks still can offer attractive returns, we believe it will be more challenging and volatile along the way.
