While it risks causing market turmoil, the Omicron variant should not cause a major stock market shock. Investors should however temper their expectations after three exceptional years in the markets.
This is the advice of Michel Doucet and his colleague Jean-René Ouellet, of Desjardins Wealth Management. Over a ten-year period, the two strategists believe that an investor with a balanced portfolio (60% stocks, 40% bonds) should expect an average annual return of between 3% and 4%.
Over the past three years, a model balanced portfolio would have provided an average annual return of over 10%, which has created a form of habit for savers, they say.
“Interest rates are already very low,” said Mr. Ouellet in an interview made a few days before Christmas. It’s going to be difficult to ask a bond portfolio to generate a 3% yield when the 10-year Canadian government bond has a rate of 1.50%. As for US equities, we are at 21 times the profits for the next 12 months, which is not a godsend. “
A high multiple does not necessarily herald a disappointing 2022 for the stock markets. In contrast, the correlation between valuations and returns is stronger in the long run. “The more you pay, the lower the future returns,” warns Mr. Ouellet.
The chief economist of the National Bank, Stéfane Marion, is also looking at the year 2022 with caution. For now, however, he sees no reason to revise his forecast lower, but he will closely monitor how China adjusts to the Omicron variant.
“The big risk factor is China’s behavior given its zero tolerance policy [à l’égard de la propagation du virus], explains the economist. If China maintains this policy, and it appears to be, it could have impacts on the supply chain given its strategic position. That being said, I am prepared to live with this uncertainty if the chain loosens up after a more difficult first quarter. “
Laugh at an “i”
The Bank of Canada and the Federal Reserve (Fed) in the United States are also expected to start tightening monetary policy next year to curb rising inflation, Marion believes. Interest rates are, however, expected to remain below the level of inflation, which is seen as a stimulus for the economy.
“I think central banks will be cautious,” predicts the economist. They are aware that inflation is higher than expected, but they are going to raise rates, maybe a little faster, but to take them into higher-than-inflation territory, that would be amazing. “
For the moment, the consensus of economists is predicting five rate hikes in Canada in 2022. At Desjardins Group, only two are expected. “I do not believe it, that we will succeed in inserting five increases in the key rate and that the Canadian economy will come out of it,” comments Mr. Doucet.
A too rapid rise in interest rates could derail the economic recovery, he said. In 2021, he notes that 50% of new mortgages are at variable rates. With so many households exposed to rate hikes, the Bank of Canada can’t move too fast, he said.
Invest closer to home
In this context, Mr. Marion is overweighting Canadian equities. He points 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. This ratio is 21 times for the S&P 500, which has the 500 largest publicly traded US companies. “Historically, the S & P / TSX has been an index that fared well in a context of higher inflation. It is an index that provides protection against inflation, more than the American index, ”he stressed.
The economist also expects the Canadian dollar to appreciate against the US dollar, which is unfavorable for Canadians who hold assets denominated in US dollars.
Marion expects profits for S & P / TSX companies to increase an average of 7% in 2022. He believes the index will hit 22,500 points by the end of the year. Large US companies in the S&P 500, for their part, would see their earnings grow at an average rate of 6.4%. His target for the New York index is 4,900 points for 2022.
The forecasts of Desjardins strategists are a little more optimistic for the two 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, Mr. Ouellet favors, for his part, several sectors with a strong presence in Canada: financials, energy companies and the materials sector.
For growth stocks, such as the tech sector, rising interest rates are a “drag” because they lower the relative value of future earnings relative to bonds. “We are going to return to growth stocks,” predicts Mr. Ouellet. We are in the post-COVID economic momentum, but the potential pace of our economies will return to normal in 2023 or 2024. In a world of modest growth, companies that will manage to generate stronger growth will earn an appraisal bonus. “