Sector Update

January 3, 2022

Last week we saw Treasury yields closed mixed and the curve flatter in light trading. Things are much different today though as yields have increased markedly in a steeper fashion pushing portions of the curve to cycle highs. We would do well to remember that even though we have flipped our calendars over to 2022, the same concerns in the market have not disappeared.

Reflecting on 2021 and Looking Forward to 2022

Looking back, 2021 was an odd year in many ways but helped reinforce three (at least) good investing disciplines. We entered the year with absolute low yields. The 3-, 5-, and 10-year Treasury yielded 0.17%, 0.36%, and 0.92%, respectively, and didn’t provide much cushion for the historically modest 60-90 bps increase in yields. This pressured returns lower for the year, especially longer duration, after two solid years of performance. That isn’t to say all longer duration investments though (more on this below). Even on a 3-year Treasury, best I can tell, 2021 was the first year a buy-and-hold investor would have experienced a negative total return in over 20 years.

Discipline 1: Portfolio diversification matters

Like I mentioned above, not all longer-duration investments struggled with returns in 2021. A sizeable portion of many depository portfolios are invested in longer-term municipal bonds which performed relatively well. Last year was likely a good reminder of the merits of a diversified portfolio. Historically, this also appears to be the case too. Looking back to 2000, there has only been one year (2013) where all the selected indices below posted negative total returns.

Discipline 2: Invest as consistently as practical

At the risk of sounding self-serving, I really do think 2021 served as a good reminder on the merits of attempting to invest as consistently as possible. Looking at some of the charts below, there were certainly times when investing would have been more/less advantageous than others. This is the biggest problem we have as investors though, being unable to predict the future. Taking a disciplined approach to purchases is a way to help combat this.

Discipline 3: Don’t forget the big picture, your balance sheet

Considering what we’ve seen it is natural for one to wonder, what’s likely to perform well in 2022? Will the curve materially flatten, will credit continue to perform well, the list goes on and on. Fortunately, the answer to this question can (and I’d argue should) be determined by the rest of your balance sheet. Coming into 2021, the risk to yields falling was largely realized and the focus had turned to a prolonged period of low rates. Most balance sheets were (and still are) poised to perform well if and when shorter-term rates rise.

That brings us to today and to 2022. Risk sentiment seems to have shifted towards shorter-term rates rising as the Fed is expected to act on recent and persistent inflation. What if yields move higher, what if the curve flattens? Don’t worry about trying to predict the future, that’s an unrealistic goal. After all, last year the Federal Reserve predicted unemployment would be 5% in Q4 of 2021 (closer to 4% in reality) and that inflation would be up 1.8% (closer to 5%). The right choice is what complements your balance sheet.

Today – Yields higher, curve steeper, equities continue to tack on gains after big 2021

Yields on 2-, 3-, and 5-year maturities remain at/near weekly highs this morning

Curve Shape – 2s5s ends the year 29 bps steeper and 6 bps below the average for 2021

Curve Shape – 2s10s ends 2021 2 bps flatter and within 5 bps of low

Sector Commentary (click on links for more in-depth look)

What We’re Reading

Market Today | Daily

Weekly Recap | Weekly, Friday

Monthly Review (December) | Monthly, 1st business day

Brokered Deposit Rate Indications | Weekly, Monday

Investment Alternatives Matrix | Weekly, Tuesday

MBS Prepay Commentary (December) | Monthly, 5th business day

SBA Prepay Commentary (December) | Monthly, 10th business day

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