Q4 2021 Update

23 December 2021


2021 was a lacklustre year for growth and smaller companies compared to 2020, as credit spreads widened and inflationary pressures became more evident. 35% of the S&P’s return came from just five stocks – Google, Microsoft, Tesla, Nvidia and Apple. The Federal reserve’s messaging also changed drastically towards the year-end as inflation became less ‘transitory’. Markets ended the year with fears of tapering and three to four further rate hikes baked into expectations. We wait to see if the Fed’s bark is louder than its bite when it comes to rate rises.


The growth in COVID cases driven by the omicron variant has become disconnected from the rate of hospitalisation and death. The high level of third dose vaccination in the UK seems to be having the desired effect. The central pinch point for the UK will be the degree to which the health service can cope as it faces an increasingly COVID impacted workforce. However, there is an evident political desire to avoid further lockdown restrictions, particularly in England.

Inflation & Interest Rates

The Fed balance sheet continued to expand in Q4 2021 despite the highly publicised policy tightening and the ambition to taper. However, the growth rate of the M2 money supply, despite still being well into double figures in Q4, is half the rate of growth year over year. The implication is that the US economy will likely see a local peak in inflation in Q1 2022. Despite this, longer-term, inflationary pressure will remain a dominant concern. The 2020s will probably be more like the 1970s and the 1940s than any time in the last four decades. With government debt levels remaining elevated through this period, Central Banks will become increasingly inventive to keep interest rates at low levels. Expect further talk of the introduction of Central Bank Digital Currencies, tighter regulations around stable coins as a means of monetising debt and the more widespread promotion (or even imposition of) of Green Bonds among investors.

Supply Chain Problems 

Politicians often encourage the thought that inflation is industry’s fault, rather than, as Milton Friedman described, “always and everywhere a monetary phenomenon”. Recently several sectors have been blamed for the emergence of shortages. One such has been the auto industry, mainly blaming the semiconductor industry for the shortage of new vehicles. This dynamic has led to the unusual situation where the inventory level of used cars is at an all-time low while that of new vehicles (mainly finished all but for a few semiconductors) is at an all-time high. When the supply of semiconductors unwinds, one can expect a period of deflationary car prices. The supply situation for autos is likely being replicated in other sectors. These “shortages” could unwind more quickly than currently expected.


European natural gas prices have spiked to levels 14x greater than those in the US. LNG exports are being sucked into Europe, which is providing some relief. However, natural gas is not cheap to export without pipelines, and in Europe, these are heavily politicised. The supply of European natural gas does seem to be more intractable than other supply chain issues.

Global Growth 

If PMI indices are early indicators for GDP growth, then the US and Europe (including the UK) seem to be heading for a slowdown in growth into Q1 2022 from the unsustainable peaks seen in Q2 2021. This slower growth will likely take the pressure off supply chains and ease the inflation pressures in the short term. The exception is China, where PMI indicators appear to be bottoming out.


The fiscal stimulus program hit a roadblock in the Senate in December last year. A revised bill should take shape in 2022. The political pressure to have a bill signed before the November mid-terms will be overwhelming. Over the last two years, the US market has had a strong run, helped by both monetary and fiscal stimulus. In year-over-year terms, the US economic growth rate peaked in Q2 2021, while Q3 and Q4 have shown decelerating (but still positive) growth, along with persistently hot inflation. Q3 was stagflationary, with GDP growth lagging the CPI inflation rate, while in Q4, GDP growth is likely to be neck and neck with CPI inflation in the 5-7% range. US employment trends indicate that labour market tightness is a function of supply, courtesy of the Great Resignation, rather than a strengthening economy, a further stagflationary indicator. With both types of stimulus likely to be less influential in 2022, the US indices might be more sluggish. However, a continuing strong dollar would help make their returns positive for overseas investors.


The Chinese credit cycle and stock market remain heavily out of sync with the US and the West. Bloomberg credit data suggests that the crackdown and tightening seen in China led to a mild level of debt reduction in Q4 2021, leaving scope for a loosening of policy in 2022. This policy shift might be motivated by the 20th CCP National Congress in Q4 2022, where Xi aims for his unprecedented 3rd term. While China retains the potential to inflict further adverse economic and financial shocks to the West, a base case for 2022 is likely for this to be less of a factor than in 2021. Indeed 2022 could turn out to be a year of re-accelerating Chinese growth, albeit it does seem likely that its housing and construction sectors will remain a drag.


The main media focus for 2022 in the UK economy is a squeezed consumer. It is becoming more widely understood that retail energy prices will have to rise by at least 50% in April, likely to coincide with one of the biggest ever increases in personal taxation. The other theme in the UK is pressure from the electoral cycle, the unanswered question of how to level up and the slump in popularity of the current government. However, the success of the UK’s vaccine booster program is less talked about, which might allow the UK to avoid the further lockdown restrictions seen in other European countries. The UK market remains attractive on most broad measures. In particular, the value of small and mid-cap stocks relative to large-cap stocks. With a weaker £ and an attractively priced equity market, the UK mid-market looks like an excellent hunting ground for M&A activity in 2022. We think there are good fundamental reasons to be more positive on small and medium-sized companies. The valuation gap between large and smaller cap stocks has been at its widest margin for some time, particularly in the UK. With omicron proving less severe than feared and easing pressure on global supply chains, we think this provides scope for better small and mid-cap returns in 2022.

Written by Jeremy McKeown