This article first appeared in the Telegraph

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

THIS is when we take stock, try to understand what the markets served up to us this year before thinking about what the next 12 months might have in store. I’ll do the crystal ball thing next week. Today is about lessons learned. What did 2021 teach us as investors?

Firstly, that markets march to a different beat. We started the year in lockdown, and we are closing it out with a potentially even more serious Covid scare. That hasn’t prevented it being a generally positive year in the markets. Wall Street, in particular, has delivered more than 25% year to date. Even if you adjust that return for sharply rising prices, it’s still an impressive real terms outcome in a year of sometimes grim headlines.

Not all markets did as well. The returns here in the UK and in the rest of Europe were around half as good but still safely in double digits. Asia was more of a damp squib - Japan up 4% and China and other emerging markets down by a similar margin. But a portfolio weighted according to the relative significance of all these markets will have provided a second good year in a row to a well-diversified investor. Compared with other recoveries over the past hundred years or so, this has been one of the best, and not dissimilar to the market rally after the Spanish flu.

The second lesson has been the ongoing dependence of financial markets on accommodative monetary policy. Again, weighted according to the importance of different economies around the world and adjusted for inflation, interest rates have never been further into negative territory, but this only tells half the story. Add in the impact of bond purchases by central banks and the effective interest rate might be as low as minus 7%. In real terms that is an unprecedented level of stimulus. No wonder the US market hit a new all-time high last week.

There really has never been anything like this. Collectively, central bank balance sheets have grown to 29% of global GDP. Two years ago, after ten years of quantitative easing and in the face of much hand wringing about excessively easy policy, they amounted to only 14%. On the fiscal side, two years of unprecedented deficits have done their job - the labour market is back at its pre-pandemic level, which itself was a re-run of the pre-financial crisis boom.

So, policy matters, which is why the Fed’s new-found determination to end its purchases of bonds as soon as next March represents such a risk to markets. The imminent end of QE opens the door to interest rates finally being lifted off the floor. No-one knows how investors will respond but history suggests not well. Fortunately, the markets are sceptical about the extent to which the Fed will actually be able to normalize policy. The futures markets continue to see interest rates settling at 2%, well below the Fed’s own assessment of a neutral rate. Investors think either the Fed will not be able to raise rates very far, or it will do so only to quickly reverse course once higher rates unsettle the economy, or the market, or both.

The third lesson we’ve learned this year is that the dragon of inflation can go to sleep for long periods, but it always wakes up in due course. On both sides of the Atlantic prices are rising faster than for many years and faster than expected. The supply chain disruption that has fuelled much of the price spiral in, for example, used cars will fade away in time. But other aspects of inflation, such as housing and wages, look stickier. Central banks are right to worry.

For investors, inflation is an insidious tax. At the current rate of US inflation, your purchasing power will halve in a decade. Here in the UK, it will take just 14 years. That is a terrifying prospect for anyone on a fixed income - retired, or invested in the bond market.

Lesson number four from 2021, however, is that markets are also driven by earnings and valuations. In both cases the news this year has been encouraging. The 48% rate of year on year growth in the third quarter in America is obviously not sustainable in the long run but it has more than justified the sharp rise in the stock market over there. Fast-rising earnings have kept valuations stable as both the top and bottom components of the price/earnings ratio calculation have risen in tandem. The growth rate is certain to moderate, but the stock market is not too expensive.

The final lesson from this year is that where and when you invest matters greatly. Fear of missing out has encouraged investors into parts of the market that they might normally have ignored. The ups and downs of meme stocks and bitcoin this year have shown the risks of bandwagon investing. Even in the mainstream, a stock like Ocado has shown that being even a little bit behind the curve can be costly. Up 170% between February and September last year, the food delivery service has since fallen by 45% as people became too enthusiastic about shop from home.

As we have seen with the geographical variations this year, the relative performance of different investment sectors and styles has also been a key determinant of investment success this year. Oil is up 40% and copper 20% but gold - the traditional safe haven in inflationary times - is 6% lower. While large tech stocks have driven the market higher, smaller growth shares have gone sideways.

The key message from another year in the markets is a familiar one. You had to be in it to win it. But without the benefit of hindsight it is never clear exactly what ‘it’ is. Putting your eggs in a wide range of baskets and staying the course has, as ever, been the right approach.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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