2022 Market Outlook

A Year in Review

Canada and the US led the way in equity markets last year, while emerging markets were slightly negative due to concerns about China’s zero-COVID response and impending real estate crisis. Meanwhile, bond markets stumbled and experienced negative returns for the first time in five years, a story which will likely persist for the duration of 2022 as interest rates begin to rise again. Supply chain disruptions also impacted the markets, resulting in much hotter and persistent inflation than was initially expected.

COVID Expectations

While the Omicron variant has proven to be highly contagious, it’s also proven to be less deadly.¹ The expectation is for “peak cases” to occur sometime towards the end of January or beginning of February, with the hope being that any drag on the economy will be short-lived. Problems related to the supply chain should therefore ease, which we’re already noticing to a certain extent. And if any new variants do appear, our hope is they will be less severe than the others. Though inflation should still remain relatively high for most of 2022, these developments should help to take the pressure off, which would be a positive for markets. Another reason for our bullish sentiment is the strength of household balance sheets, resulting from robust equity and housing market growth, lower debt rates and a booming job market.

Interest Rates and Yields

Unsurprisingly, given the stubbornness of high inflation, interest rates will likely be going up sooner rather than later. This aligns with the U.S. Federal Reserve’s hawkish tone in recent meetings and public statements. As such, we can expect three to four rate hikes in 2022 in both Canada and US, though Canada could go even earlier if warranted. It’s also possible Omicron may delay these rate increases somewhat depending on the severity and length in both countries. We can therefore expect yields to continue moving higher beyond the 2.0% level and then settle down a little. As expected, this should have negative implications on bonds and long duration equities.

Consumer Strength (U.S. and Canada)

The key to our bullish stance is consumers: they benefitted greatly from a boom in housing values, equity markets and employment opportunities. At the same time, we saw broad increases in net worth and disposable income during the pandemic, as many people chose to pay down debt and put away savings. When you combine these factors, it means that consumers are equipped to purchase more goods and services once the economy opens up, which will provide a macro tailwind in the near term.

Valuations

Equity valuations are by no means inexpensive, but they are cheap relative to bonds. For example, if you look at the equity yield of the S&P 500 compared to the 10-year bond yield, equities win quite handily. Layer in expectations for stock buybacks and dividend increases, coupled with future earnings growth and a rising interest rate environment, and the case for equities only gets stronger. On the latter issue, it’s important to note that rising rates aren’t necessarily bad for equity markets, since they’re usually an indicator of a strong economy.

Value vs. Growth

It’s an open secret that Growth has dominated Value for a significant period of time. And while some analysts jumped on the Value bandwagon last year (as the economy started to look like it was back on track), the reality was we were still in COVID protocols. However, there’s another conduit for the rotation: higher interest rates. Growth names are effectively long duration assets, and therefore don’t do as well in a rising rate environment. We have already seen selling pressure in those areas of the market, with Energy and Financials starting to do really well, but it should be noted that the biggest technology companies will likely have a floor to limit big drawdowns.

However, it is not only just about value and growth. Sectors that got hurt in the past few years during the pandemic may also start to be revived, which means areas like travel and tourism could outperform in 2022 should the COVID situation improved significantly.

Portfolio Positioning

As noted, we want to be overweight equities and, more specifically, US and Canadian equities. Any pullback in these markets (like we are witnessing now) could provide great buying opportunities moving forward. By contrast, we expect to be underweight EAFE due to their COVID situations and ongoing supply chain bottlenecks. However, we are neutral on China (and the broader Emerging Markets) given recent pullbacks and signs of some stability on the regulatory front. This is one area that we will be watching for buying opportunities, given the attractive valuations at present. When it comes to bonds and credit, we remain underweight both, in particular for high-yield assets where a pullback appears inevitable after their recent run-up. There are no changes to our Style/Factor approaches – except for a possible shift to Quality – and our preferred tilts in sectors are towards Energy, Financials and Travel and Tourism, with all three benefitting from a reopening trade. Meanwhile, on the currency front, we remain neutral on the Canadian dollar versus the US dollar but also expect USD to outperform the world basket of currencies.

¹ Max Kozlov, "Omicron’s feeble attack on the lungs could make it less dangerous," Nature, January 5, 2022. https://www.nature.com/articles/d41586-022-00007-8#correction-0