Australian shares delivered double-digit gains in 2021, powered by a surge in the first half of the year that gave way to flat performance from August as national lockdowns, inflation fears and turmoil in China dominated headlines.

The Morningstar Australia Index, a benchmark of the top 97% of stocks by market capitalisation, notched a total return of 18.4% in 2021, or 14.1% excluding dividends. It was the fourth best showing in the last decade, several points behind the 23.4% marked in the year before the pandemic.

Markets rose steadily to their mid-August peak as the V-shaped economic recovery was turbocharged by soaring iron ore prices. Flush savings accounts and generous government handouts stoked economic fires at home, helping unemployment fall to 4.5% in August from the pandemic peak of 7.5%. Overseas, strong Chinese demand kept iron ore prices hovering above US$200 for most of May and July.

Then came covid. The June outbreak mothballed the economy for months and gross domestic product (GDP) fell by 1.9% in the third quarter. Overseas, state-mandated cutbacks in Chinese steel production and debt troubles in the commodity-hungry property sector added to iron ore's woes, with the price halving over August and September.

In the background markets and central banks played a cat and mouse game over rising inflation and the future of interest rates. ‘Team Transitory’ gave way by to a more hawkish stance at the world’s major central banks. The US Federal Reserve is now signalling three rate hikes in 2022.

The prospect of higher interest rates did little to derail the record showings on overseas bourses and Australians who participated in the rush to invest in foreign developed markets were amply rewarded.

Benchmark indexes in the US, UK and Europe all returned more than 20%. The Morningstar US index recorded its best three-year return in 24 years, capped by a 27% gain in 2021.

Asian markets struggled in an otherwise strong year for global equities. The Morningstar China index shrunk 21.7%, its worst return in a decade as investors nursed share price routs at flagship firms in the property and technology sectors. Shares in tech-giant Alibaba Group, touted as China’s homegrown answer to the US technology giants, almost halved over the course of the year.

Oil and technology disappoint on the ASX

Strong performances at blue-chip stalwarts like Telstra and the major banks helped the Morningstar Australia index balance out a disappointing year in energy and technology.

Communication, financial services and real estate were the top performing sectors, overshadowing the broader index with total returns ranging between 24.6% and 34.2%. Telstra covered itself in glory with a 46% total return as investors rallied around the company’s “T25 strategy”.

Australian investors are still waiting for the global rebound in energy stocks to arrive down under. The local energy subindex returned just 3.4% in 2021, versus the 55.7% notched by the US equivalent. A spike in oil and gas prices over in the third quarter raised hopes and saw shares in local players leap, before reversing gains by year end.

Shares in Woodside (ASX: WPL) rebounded to above $25 in October as rising energy prices padded out revenue before declining steadily to finish the year at $21.93.

A volatile year saw the Morningstar Australia technology index clinch the wooden spoon, with a return of 2.21%. The sub-index notched the biggest one month gain of any sector in August, leaping 18.4% as Afterpay (ASX: APT) clinched its deal with US payments giant Block and WiseTech Global (ASX: WTC) crushed earnings expectations. Outside that month, performance was more down than up, as the all-important BNPL sector struggled with higher competition and regulatory scrutiny.

Commodity market turmoil dominated the all-important resources sector. Shares rose in line with iron ore prices to an August peak before cutbacks in the Chinese steel sector crimped demand and reversed gains. The sector rebounded in the latter half of the year to record a total return of 15.1%.

Value funds cheer the changing tide

Value stocks staged a resurrection in 2021, riding the recovery in economically sensitive sectors such as banking.

The average Australian Large-Cap Value fund returned 18.4% last year, just pipping their growth equivalents which brought in 18.3%.

A year earlier those same funds were nursing an average loss of -2.13% while growth funds soared thanks to bets on technology and the “lockdown economy.”

Silver rated Lazard Select Australian Equity is one value manager celebrating the reversal of fortunes. An overweight position in Whitehaven Coal (ASX: WHC) going back to March 2019 returned 58.66% last year, making good on the 36.5% fall suffered in 2020.

"It's a willingness to back valuation and the view you have. When we saw the prices that were there, they were absolute guineas and we saw a lot of money for our clients,” said portfolio manager Aaron Binsted, speaking with Morningstar in October.

2022 kicks off with volatility

More volatility is on the horizon if local share markets begin reverting to historic norms after a year of record calm on the ASX.

Australian share markets were the calmest in more than a decade last year, with an average drawdown of -2.14%—well short the -6.8% averaged over the last decade. Drawdowns measure the distance between peak to trough during a downturn and are the result of volatility.

Investors were treated to their first wobble just three days into the year’s trading. The ASX recorded its biggest fall in sixteen months last Thursday as markets reacted to news the US Federal Reserve had discussed accelerating tightening in its last policy meeting.

Technology-heavy US markets were hit hardest. The US Nasdaq Composite is down 5.6% after its first week as investors fret higher rates could hurt growth stock valuations. Roughly 40% of stocks on the Nasdaq are down more than half off their 52-week high according to Bloomberg.

For now, Australian investors are insulated from the pain because of the local index’s weight to miners and banks insulates it from growth stock troubles. Seven per cent of the stocks on the Morningstar Australia index are down more than 50% off their 52-week highs, with Nuix, Zip and Magellan falling furthest.