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What's Old is New Again

by Victor K. Lai, CFA


2021 ended in an unremarkable way (perhaps a good thing given the events of 2020). In many cases, we saw a continuation of the same old, same old. For example, we ended 2021 with yet another strain of COVID. This time last year many people (myself included) were hopeful we’d put the pandemic behind us. That was indeed hopeful thinking as we are in year 3 of what looks like the same old thing and what may become a new normal.

And also like 2020, the financial markets had another strong year. Global equity market prices climbed +18.74%. US stock prices led the way up +29.38% while traditional safe havens like US bonds and gold ended down -1.69% and -3.79%, respectively.

Figure1: Global Markets

As usual, my fortune-telling from last year’s letter had mixed results. My preference for the energy sector played out better than expected. US energy stocks substantially outperformed the S&P 500 and were actually the best-performing equity sector of the year, energy stock prices were up +52.00%

Figure 2: Energy Sector

My preference for value over growth stocks, however, was less decisive. While value did lead for most of the year (first time in, like, forever), by year-end growth managed to outperform the old value dogs once again.

Figure 3: Growth vs Value

My preference for foreign equities over US also did not work in my favor as the S&P 500 led the way up. Such is the haziness of my crystal ball. Be that as it may, the best way forward is still to look on ahead.


In Q1 of 2021, we shifted from being more cautious to more constructive as various big-picture concerns from 2020 were laid to rest. Last year I wrote,

“Economic conditions so far this year have mostly unfolded as we expected. Despite incessant back and forth over the pandemic, vaccines are disseminating, stimuli are distributing, and people are re-emerging from self-imposed hibernation.”

That led us to a modest tactical overweight of risk assets above their long-term strategic targets. The rationale was the path of least resistance was a continuation of global economic expansion and support for risk assets. That much played out during the year.

At the onset of 2022, we are shifting back to a more cautious outlook due to several reasons including a maturing business cycle, fading government stimulus, and persisting inflation. The risk with inflation is that it will force the Fed into raising short-term interest rates too much. Last March I wrote,

“The most likely path towards a continued surge in rates is if inflation comes in hotter than expected. In that case, the Fed could be forced to hike rates and inadvertently deflate the stock market.”

For most of 2021, the Fed insisted inflation was “transitory,” was driven by temporary supply chain disruptions, and would recede. It did not see a need for pre-emptive tightening. But since then, the Fed conceded inflation was more persistent than it expected.

In November 2021, in a statement to Congress, Chairman Powell went as far as to say it was time to “retire” the word “transitory.” At its December FOMC meeting, the Fed signaled its plan to tighten monetary policy sooner than expected by pulling forward “tapering” (i.e., ending bond-buying activities, aka “QE”), and setting up for rate hikes in 2022 (previously not expected until 2023).

This is an about-face in monetary policy, from dovish indifference to hawkish concern that inflation is a threat. That matters because the Fed has a long history of tightening into contractions. The chart below shows the US Federal Funds Rate (blue line) since 1954 with recessions highlighted (grey bars). Notice that, without fail, every US recession was preceded by the central bank raising the Federal Funds Rate, including the flash-recession of 2020.

Figure 4: Federal Funds Rate

This isn’t random, short-term rates (which the Fed controls) is effectively the price of money. When rates are low and money is cheap (as it has been) market participants are encouraged to use it, whether that’s to borrow it, spend it, or put it into financial assets like stocks, bonds, or even (dare I say) cryptocurrencies.

At near-zero rates (and negative real rates) investors are induced to throw caution to the wind, trading anything and everything for cash that is “trash.” That at least partially explains the recent irrational exuberance we’ve seen in markets. Ultimately, all that’s supposed to stimulate economic growth.

However, as rates rise and money becomes more expensive, market participants also become more cautious and selective about how money is spent. Taken too far, this upends economic growth and recession follows.

With that in mind, a curious thing is happening with interest rates. Despite hot inflation and the realization that the Fed has been cornered into tightening, long-term rates have actually been declining since October 2021 and the 10-Year Treasury yield is back near a 1.5% handle.

Figure 5: US 10-Year Treasury Yield

If expectations were for stronger inflation and stronger growth, we’d expect to see long-term rates rise. Falling long-term rates suggest the market is sniffing out weakening economic conditions ahead. That paired with Fed tightening would be a recipe for a “bear flattening” of the yield curve. In other words, short-term rates rise and long-term rates fall causing the slope of the yield curve to flatten.

To be clear, flattening itself is not the concern, but a bear flattening increases the risk of a yield curve inversion (whether by policy misstep or market sentiment) and that would be troubling. Recall that inversions are a strong leading indicator for both recessions and bear markets (thus the term bear flattening). After rising to steep levels in 2021, the yield curve has flattened back down to 2020 levels. If this trend continues in the face of Fed rate hikes, we would be on the lookout for inversion.

Figure 6: Treasury 10-2 Year Yield Curve

To be clear, I’m not calling for a recession in 2022 (I don’t know when the business cycle will turn or when yields will move). Realistically I’m talking about a potential bear flattening that could potentially lead to an inversion – not exactly a precise prediction! Also, it can take months and even years after rate hikes or inversions before a recession materializes.

What I am saying is conditions heading into 2022 are different than 2021. Like the Fed’s easy monetary policy, the market’s easy money is behind us. The period in the market cycle when prices only go up has passed, and moving forward we should expect increased volatility and bouts of risk aversion as markets adjust.

As such we’re tactically adjusting our exposure to risk assets from overweight down to their strategic targets. Please note that doesn’t mean “we’re getting out of the stock market.” On the contrary, to be at our strategic targets means we are fully invested relative to our long-term risk targets. However, it does mean we do not see a compelling case for extending risk exposure or reaching for returns. It also prepares portfolios for de-risking below strategic targets when that becomes appropriate.


Market valuations remain elevated across asset classes and at best we see pockets of relative value. Here are a few pockets we’re rummaging in.

Really real in Brazil

In October, I wrote about the Brazilian equity market. Conditions haven’t gotten better and Brazil earned the distinction of being the worst-performing equity market in the world for 2021 (by country). Brazilian stocks are down over -30% from their highs in June 2021 and near -40% from January 2020. The consensus is there’s more to come and the pain is about to get really real in Brazil.

Figure 7: Brazilian Stock Market

There may very well be more downside from here. Brazil’s problems are well known. Dysfunctional government, surging deficits, and a horribly botched response to the COVID-19 pandemic that had some calling President Bolsonaro to be tried for war crimes. Add inflation and the falling value of the Brazilian Real (not helped by US tightening), and we have the hallmarks of an emerging market death spiral. So yes, the negative sentiment is understandable.

That said, these issues are not unique to Brazil and are actually common among emerging markets. What’s different about Brazil is its size. Brazil has the third-largest economy and second-largest population in the Americas (globally it’s the sixth most populated country in the world). The point is Brazil is too big and too important to fail.

Barring Brazil becoming a failed state, the more likely outcome is it recovers back onto its trajectory as a face of the long-term emerging market growth story, the very “B” in the emerging market “BRIC” acronym. Meanwhile, Brazil is showing signs of life. Employment and spending have bounced off their 2020 lows and continue to move in the right direction.

Figure 7: Brazil Employed Persons

Figure 8: Brazil Consumer Spending

And at a time of ever-stretched equity market valuations, Brazil stands out as one of the most attractively priced equity markets within the only reasonably priced equity market segment in the world, summarized with respective ETFs below.

Figure 9: Equity Market Valuation Multiples

Sources: Morningstar, ETF.com, BCM, as of 11/30/2021

Of course, there are also many real risks. Accelerating or decelerating, Brazil’s economy is on shaky ground at best. As noted above, a pivot into monetary tightening by the US and other countries would add additional stress to an already fragile situation. Realistically, a 40% move is not extreme for EM stocks, there could be substantial downside from here, and I don’t know when Brazil finds bottom.

What I do know is pessimism is pervasive, expectations are very low, and Brazil only needs to perform less badly than expected for an upside surprise. Meanwhile, valuations look attractive enough to warrant attention. My expected return estimate for a broad Brazilian equity market fund (like EWZ) is +90% at current prices or better. We will continue to build a position on price weakness.

All that glitters and gold

Time and again market history has taught us “all that glisters is not gold” (h/t Shakespeare). That statement could not be any more relevant in today’s markets which glisten with shiny new objects as far as the eyes can see (crypto, SPACs, meme stocks, etc.). Like The Merchant of Venice, we’ve watched this play out before and know how it ends.

Each shiny new object inevitably loses its luster, but gold continues to outshine the test of time. No other asset has been so universally recognized as a store of value and medium of exchange across eons. While crypto-bulls may argue Bitcoin is digital gold (and admittedly it does share similarities), BTC obviously lacks the tangible and physical qualities that make gold unique. Put simply, in the wake of a major catastrophe (or just a major power outage) one would more likely have success bartering for food with gold coins than digital tokens.

Like BTC, gold also has its problems. Gold has a cost of carry, produces no cash flows, and is inherently difficult to value. Despite that, gold has a long, unrivaled, and undisputed history of outlasting fads, economic cycles, and empires while finding new highs along the way. Even more impressive than gold’s long history is its ability to zig and zag at the right times.

Figure 10: Gold Prices

Source: Macro Trends (log scale)

Gold has a solid record of standing its ground or rising in value during times of uncertainty. The pandemic, the financial crisis, the tech bubble, Black Monday, and the oil embargo were all periods in modern history when gold helped dampen substantial drawdowns in equity markets. With inflation recently hitting the highest levels since the 1980s (CPI at 6.8% y/y in November) an allocation to gold looks both sensible and attractive.

Figure 11: Gold Versus Inflation

Gold = Year End Spot Prices (LHS). CPI = YoY Change (RHS).

Sources: BLS, FRED, BCM.

Some may point out gold has already seen a sizable move to the upside since 2018. That’s true, but so have most assets. In relative terms, gold actually hasn’t moved that much. As a crude example, the ratio of the S&P 500 to gold prices is near the second-highest level of all time (bested only by the tech bubble of the late 1990s). That may be a better indication of extreme valuation in US stocks. However, whether US stocks are too expensive or gold is simply less expensive than US stocks, that’s still relative favor for gold.

Figure 12: S&P 500 to Gold

Source: Macro Trends

Lastly, given the challenges that fixed income investments may face in a secular rising interest rate environment, gold may have a more permanent (versus tactical) place in many investor portfolios. All things considered, gold provides an attractive combination of inflation protection, relative value, and a hedge against equity market risk. As such, we’ll look to opportunistically add to our gold position over time.


We enter 2022 with a pivot. Whereas 2021 saw tailwinds to the upside, 2022 faces increasing headwinds and slowing momentum driven by decreasing stimulus, central bank tightening, and inflationary pressure. I’m not calling for a recession (absent an unseen macro shock), but for continued moderation and progression through the business cycle.

That means the “easy money” and easy Fed are behind us and increasing market volatility is ahead. As such we’re reducing our portfolio risk exposures down to their strategic target weights. That’s not a bearish position because target weight is still fully invested. However, it is easing the foot off the gas pedal and posturing for decreasing risk exposure ahead.

Global market valuations are still elevated across the board and good values are hard to find. However, we see opportunities in foreign equity markets, favoring emerging markets in general, and Brazil in particular. Gold is also becoming increasingly attractive for a number of reasons I elaborated on above.

After all that’s happened over the past two years, it seems the world is finally getting back to where we left off in 2019, and what’s old is new again. Not without changes, of course. For BCM, that included completing our relocation up to the Sierra Foothills in Northern California last year.

The blue waters of Lake Tahoe and massive redwoods of the El Dorado Forrest are a refreshing change of scenery (and lifestyle) from the concrete and hustle-bustle of the Bay Area. We’ve settled into our new office space and couldn’t be happier with the move, come see us on your way up to the slopes!

As always, I want to express my sincerest gratitude and appreciation for another great year at BCM. To our clients, families, and friends alike, thank you for your trust and confidence. It is your continued support that keeps us striving to do our best and improve every day. We wish you the very best in the year ahead.


My Best,

Victor K. Lai, CFA

Bellwether Capital Management LLC (BCM) is a registered investment adviser (RIA). It provides investment management and consulting services for people and organizations. Please visit www.bellwethercm.com to learn more.


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