While it may cause stock market turbulence, the Omicron variant should not cause a major stock market shock. However, investors should temper their expectations after three exceptional years on the markets.
The above is Desjardins Wealth Management Michel Doucet and his colleague Jean-René Ouellet’s advice for those looking for guidance in 2022.
Over a 10-year period, the two strategists believe that an investor with a balanced portfolio (60 per cent stocks, 40 per cent bonds) should expect an average annual return of between 3 and 4 per cent.
Over the past three years, a model balanced portfolio should have provided an average annual return of more than 10 per cent, which they believe has created a form of habit for investors.
“Interest rates are already very low,” said Ouellet in an interview a few days before Christmas. “It’s going to be hard to ask a bond portfolio to generate a 3 per cent return when the Canadian 10-year government bond is yielding 1.50 per cent. On the U.S. equity side, we’re at 21 times next 12 months’ earnings, so that’s not a bargain.”
A high multiple is not necessarily a sign of a disappointing year in 2022 for the stock markets. However, the correlation between valuations and returns is stronger over the long term.
“The more you pay, the lower the future returns,” warned Ouellet.
National Bank’s chief economist, Stéfane Marion, also views 2022 with caution.
For the time being, however, he sees no reason to revise his forecasts downward, but he will keep a close eye on how China adjusts to the Omicron variant.
“The big risk factor is China’s behaviour given its zero-tolerance policy toward the spread of the virus,” he said. “If China maintains this policy, and it seems that it will, it could have impacts on the supply chain given its strategic position. That said, I’m willing to live with the uncertainty if the chain unclogs after a more difficult first quarter.”
THE ‘I’ WORD
The Bank of Canada and the Federal Reserve (Fed) in the U.S. are also expected to begin tightening monetary policy next year to curb rising inflation, Marion believes. However, interest rates should remain below the level of inflation, which is seen as a stimulus for the economy.
“I think central banks will be cautious,” he said. “They know that inflation is higher than expected, but they will raise rates, maybe a little bit faster, but to get them into higher territory than inflation would be surprising.”
“For the time being, the consensus of economists is for five rate hikes in Canada in 2022. I don’t believe that we will succeed in raising the rate five times and that the Canadian economy will recover,” said Doucet.
If interest rates rise too quickly, the economic recovery could be derailed, he said. By 2021, he said that 50 per cent of new mortgages are variable rates. With so many households exposed to rising rates, the Bank of Canada can’t move too fast, he said.
INVESTING CLOSER TO HOME
Against this backdrop, Marion is for loading up on Canadian stocks.
He pointed out that the S&P/TSX, the Toronto Stock Exchange’s flagship index, is trading at nearly 14 times analysts’ earnings forecasts for the next 12 months. “Historically, the S&P/TSX is an index that has done well in a higher inflation environment. It’s an index that gives protection against inflation, more so than the U.S. index,” he said.
The economist also expects the Canadian dollar to appreciate against the U.S. dollar, which is unfavourable for Canadians who hold U.S. dollar-denominated assets.
Marion expects S&P/TSX corporate profits to grow by an average of 7 per cent in 2022. He believes the index will reach 22,500 points by the end of the year. The large U.S. companies in the S&P 500, for their part, would see their earnings grow at an average rate of 6.4 per cent. Its target for the New York index is 4,900 points for 2022.
Desjardins strategists’ forecasts are a little more optimistic for both indices. Their target is 23,000 points for the S&P/TSX and 5,200 points for the S&P 500.
By preferring the value style to the growth style, Ouellet favours several sectors that are well represented in Canada: financials, energy companies and the materials sector.
“For growth stocks, such as the technology sector, rising interest rates are a drag because they lower the relative value of future earnings compared to bonds. We’re in the post-COVID economic momentum, but the potential pace of our economies will return to normal in 2023 or 2024,” he said. “In a world of modest growth, the companies that are able to achieve higher growth will deserve a valuation premium.”
— This report by The Canadian Press was first published in French on Jan. 1, 2022.