BlackRock’s Weekly Market Commentary: Three investing lessons of 2021

By the BlackRock Investment Institute

As 2021 draws to a close, we draw three lessons. First, you need a compass to navigate the unique backdrop of a noisy restart of economic activity. Ours was the New nominal: The policy and market response to inflation would be historically muted. Second, realise that the journey for the world to reach net-zero emissions by 2050 is starting now. Third, have courage of conviction. We didn’t always have it. We had conviction the New nominal was real, but didn’t put enough risk behind it.

Chart of the week

MSCI AC World equity earnings growth estimates, 2014-2021

2021 has been marked by a confluence of events that have no historical parallel: a unique growth surge, a supply-driven spike in inflation and new central bank frameworks that are stress-tested in real time. Our anchor to interpret this macro environment has been that normal business cycle logic does not apply. The COVID-19 shock was more akin to a natural disaster, followed by a powerful restart of economic activity. This restart is nothing like the long, grinding recovery following the 2008-2009 financial crisis. It’s more like the world turned the lights back on.

Economic activity surged, corporate profits rebounded at an astonishing pace in the restart, and developed market (DM) equities ripped. The chart shows how analysts have scrambled to upgrade their earnings forecasts to a 52% jump in 2021 (the red line). We had long warned of higher inflation after decades of disinflation. Inflation is here now. It’s being driven by supply bottlenecks coupled with unusually strong household spending on goods, rather than services. We expect it to settle at higher levels than pre-COVID even as pressures from supply bottlenecks ease. In the past, central banks would already have started to raise policy rates, and bond yields would have spiraled upward. Not this time.

Many central banks were content to let inflation run higher, and bond yields moved up only modestly relative to the inflation picture. The New nominal theme helped foretell this unusually muted response to rising inflation, and was the compass that has guided us throughout the year. The Fed last week belatedly acknowledged inflation risks, and we expect it to start raising rates next year. That’s a big change, but what matters are the rate trajectory and destination. We don’t see rates going as high as they would have historically in the next phase of the New nominal.

The second investing lesson of 2021: the transition to a more sustainable world is happening now, not at some distant point in the future. First, surging fossil fuel prices in 2021 have exposed a lopsided transition toward low-carbon power. We still see an orderly transition in the medium term – but with bumps on the way leading to growth and inflation volatility. But we think inflation pressures would be even more acute and growth lower in case of a disorderly transition or no-climate-action scenario. Second, the tectonic shift toward sustainable investing is already playing out, and we believe this will give sustainable assets a return advantage for years to come. Climate-driven repricing has already started, we believe, with carbon-efficient sectors able to lower their cost of capital. Lastly, carbon-heavy companies are not waiting for new climate policies but are changing their business models now, opening up selected investment opportunities.

Our third lesson of 2021 is having courage of conviction. Our macro framework – the New nominal playing out in the restart – kept us positive on equities and underweight government bonds throughout the year. But we did not put enough risk behind our view in hindsight, even considering this has been a tricky environment where things can change quickly. Having courage of conviction is not about adding risk per se, it is also needed when your framework tells you it’s time to pull back on risk-taking. The speed and magnitude of some market moves also surprised us. An example: the swings in 10-year U.S. Treasury yields as different market narratives on growth, inflation and the virus took hold in quick succession.

Where does all of this leave us heading into 2022? We are still overweight equities even as the Omicron virus strain and the Fed’s catching up to inflation reality have hurt risk sentiment. We expect new virus variants to delay, but not derail, the restart and see policy rates rising only modestly in the New nominal’s next phase. Our 2022 Global outlook will lay out the full picture next week, including refreshed granular views for tactical and strategic asset allocation.