January 13, 2022

Financial Letter - January 2022

2022 outlook: The beginning of the end

 

The stock market’s performance in 2021 was a nice surprise given the uncertainty caused by the pandemic. In Canada, the stock index’s return was generated by all of its securities. However, in the United States, five securities represented one third of the S&P 500’s return in 2021, and more than 51% of its return after April 2021. Large-cap tech stocks were in first place. It seems that this was another example of polarization in the United States.

 

This year promises to be quite different. While historically low interest rates have favoured securities with strong long-term growth but no profits (long-duration assets), anticipated rate hikes could have a negative impact on this overvalued market segment. We expect value stocks with reasonable growth and P/E ratios to take the lead when it comes to returns.

 

This category includes cyclical securities and, more specifically, those in the energy sector, which, after seven years of bad luck, saw a rebound in 2021. We particularly favour natural gas producers, which are critical to a successful energy transition. In fact, we’ve added ARC Energy and Tourmaline to the global portfolio in the last few months, and we recently added Cheniere Energy, the largest LNG producer in the United States.

 

The financial sector is also benefiting from the upward trend in interest rates and the resurgence in popularity of value stocks. We see opportunities in both the Canadian and US banking sectors. With a P/E ratio of 12 and a dividend yield of approximately 3.5%, the Canadian banking sector should offer some stability amid increased volatility. Canadian banks have over $50 billion in excess capital. Now that the regulatory authorities have granted them permission to redistribute excess capital, they’ll be able to reward shareholders in the form of dividend increases and/or share buybacks.

 

Despite the risks posed by Omicron, global economic growth should be above average in 2022. While inflation is an issue for businesses and consumers, it should begin to subside over the course of the year as the supply chain normalizes. The Fed will maintain a hawkish stance (which favours higher interest rates) in order to keep inflation fears at bay. We can therefore expect a lot of volatility around Fed meetings, as we saw on January 5 when the market took a 180-degree turn and then declined sharply. However, these corrections will be temporary as long as the economic situation remains positive and the Fed doesn’t become too aggressive. You could say that the Fed is all talk but little action. It rarely walks the talk, as the last thing it wants is to tighten the vice too quickly and endanger the strong but fragile economic recovery. The high level of government debt is also a deterrent to a major rate hike.

 

Nothing is certain in this world, especially during a pandemic. Let’s hope that 2022 is marked by a return to normal. The US stock market has failed to see a correction of more than 10% in the current cycle, which began in March 2020, and it never dropped more than 5% last year. This is unusual. We experienced six corrections of more than 10% during the previous bull market cycle, which lasted from 2009 to 2019.

 

In short, we remain positive about equities, but we expect returns to be more modest in 2022. The year 2020 was marked by an increase in P/E multiples, and last year saw a sharp increase in profit margins. This is generally the case in the first and second years of a market recovery (bull market). In 2022, sales growth should remain strong, but pressure will be felt on profit margins, which are at record levels, and on P/E multiples as interest rates rise. BCA Research forecasts a total return of 8% for the US stock market.

 

The outlook for the alternative to the stock market is less rosy. The bond market’s performance is heading in the opposite direction of rates. To mitigate the impact of a rate hike on the value of the bond portfolio, we’re maintaining a shorter duration than the Canadian bond index.

 

We’re all hoping for the beginning of the end of the pandemic, but the title of this article mainly refers to the beginning of the end of 0% interest rates!

 

All the best for a happy and healthy new year!