Listen to On the Minds of Investors
There was no shortage of market catalysts to begin December, with the emergence of the Omicron variant and hawkish comments from Federal Reserve (Fed) Chair Powell stirring the markets. The Fed later formally announced an accelerated pace of tapering, aiming to conclude asset purchases by March 2022. This allows more time for potentially three rate hikes this year implied by its “dot plot” of future rate expectations. Firming economic data supports a less accommodative Fed, as the unemployment rate fell to 4.2% in November and headline inflation rose 6.8% y/y, the highest in nearly 40 years. Although the data suggest that conditions for rate hikes—maximum employment and inflation overshooting the Fed’s 2% target—are crystalizing, less fiscal spending and moderating consumer demand by mid-year could slow growth and limit the number of rate increases this year.
Despite various setbacks and uncertainties, the S&P 500 rallied into the end of the month (+4.5%) and had its best December since 2010. DM equities (+5.1%) managed to outpace U.S. large cap, and U.S. small cap (+2.2%) and EM equities (+1.9%) posted respectable gains. U.S. fixed income, the only positive major asset class in November, declined -0.3%, capping off its worst year since 2013. U.S. 10-year Treasury yields were range-bound for most of the month, ending at 1.52%.1 However, yields have since climbed above 1.70% in the early trading days of January. From tapering to tightening, investors should be prepared for rising rates and a steepening yield curve.
Positioning in December reflected investors adjusting to these challenges in fixed income. J.P. Morgan Asset Management’s Portfolio Insights team reviews thousands of financial advisor portfolios each year, providing timely information on average asset class positioning for 60-40 portfolios. Based on this sample, investors reduced portfolio duration by one-third to an average of 4.7 years over the course of 2021 to prepare for rising rates. Yet, the Short-Term bond category was near its lowest allocation over the last 12 months in December, perhaps reflecting recent gyrations in short-term yields. Instead, Ultra-Short has been a beneficiary, with the average allocation rising 1%-point last month. Inflation-Protected was near its maximum, reflecting concerns over surging inflation. However, investors should consider the duration of these investments carefully as capital losses from rising rates could offset inflation protection. Allocations to Core and Core-Plus continue to fall, as investors lean on areas like High Yield for income and Multisector for flexibility.
Broadly, some degree of repositioning is warranted to manage fixed income headwinds. However, we would advocate for those shifts to remain subtle; the environment for fixed income may be changing, but its primary role as portfolio ballast is not.
Range of investor portfolio allocations to key asset classes over the last 12 months
Morningstar categories, percent of average total investor portfolio
Source: J.P. Morgan Asset Management. Asset classes listed represent Morningstar categories. Bars represent the high and low average allocations of all moderate portfolios run through JPMorgan's Portfolio Insights tools, observed over the trailing 12-month period. Dashes mark current average allocations as of December 31, 2021. Asset classes listed represent Morningstar categories.
1FactSet, MSCI, Russell, Standard & Poor’s, Spectrum, J.P. Morgan Asset Management. Large cap: S&P 500, Small cap: Russell 2000, EM Equity: MSCI EME, DM Equity: MSCI EAFE, Fixed Income: Bloomberg US Aggregate. Returns are total return. Past performance is not indicative of future returns. Data are as of December 31, 2021.