Moving into 2022
It’s a proven statistic that approx. 90% of the reported news we read is negative. This holds very true in recent months with financial headlines that have had no shortage of negative news.
- “70’s Horror Show as investors freak out about stagflation, a relic of the Carter Years” wrote Fortune magazine.
-“Gas prices skyrocket as Global energy crisis worsens” CNN.
-“Will kids get their toys on time as supply chain worsens?” Washington Post.
It is easy for these headlines to alter one’s view of reality. Conversely, I feel that fortunately, over the long run, better information leads to better outcomes for everyone involved.
By looking past the headlines and digging into qualified analysis, a truer, more clear path is often laid out.
Below is a summary of several key factors that affect the economy and our investments… regardless of what headlines are saying! We know there is a lot of jargon and economy lingo here and the definitions are a little heady. We want to simply say that these points are the TRUE drivers of the economy’s health and what steer the markets. Headline news has a short “news cycle” impact, often written to capture attention rather than accuracy.
12-month Macro Risk Outlook
From current level
The U.S. economy and others around the world continue to recover, supported by consumer spending, accommodative central banks, and increased vaccination rates globally. Economic growth has likely peaked but will remain above pre-pandemic levels.
Risk to the downside
Earnings recoveries tend to see a P/E contraction. Trailing S&P 500 12M P/E ratio falls 1‒3 multiples over the next 12 months on rising earnings. Our base case is for S&P 500 valuations to moderate as earnings continue to grow.
Earnings growth is anticipated to remain strong into 2022. However, it'll likely slow relative to 2021 on margin compression (rising input costs, wages, interest rates).
The Federal Reserve and Bank of Canada maintain their accommodative policy through the first half of 2022. Short end of the yield curve is likely to shift modestly higher in anticipation of a potential rate increase in H2 2022. Longer end of the curve steepens as the recovery takes hold and inflation is sustained above central bank targets.
Credit spreads remain range-bound near current levels. Returns are predominantly yield driven as bonds come under pressure from a rising yield environment. High yield is favoured over investment grade as a source of income. Risk of a credit event is very low.
Oil prices stabilize with West Texas Intermediate between US$65‒75/bbl over the next 12 months, with risk to the upside on near term price shock.
Risk to the upside
CAD/USD trends higher with a target range of US$0.81‒0.83 over the next 12 months, with risk to the upside based on oil prices and two-year rate differential.
Here are two interesting charts that show the average monthly rate of return for the S&P/TSX along with the percentage odds in having a positive return month by month. Some interesting perspective as we take the appropriate long view of the markets.
Odds of a Positive Monthly Return
Average Monthly Historical Rate
PMI (Global Purchasing Manager’s Indices)
What are they?
The Markit Purchasing Manager’s Indices (PMIs) are monthly economic surveys of carefully selected companies compiled by HIS (economic analysis Headquartered in London) Markit. They provide advanced insight into the private-sector economy by tracking variables such as output, new orders, employment, and prices across key sectors. Economic analysts, business decision-makers, forecasters, and policymakers use the PMI surveys to better understand business conditions in any given economy. A reading above 50 indicates that the manufacturing output is growing while a reading less than 50 signals that it’s contracting.
What are they saying? Of the 31 nations for which September data were available, 24 registered PMI readings above the 50.0 no-change mark which signals expansion. European manufacturing dominated the top of the growth rankings, with nine out of the 10 best readings. U.S. manufacturing also performed strongly (third place overall). The weaker performances were generally seen in Asia. Of the 12 lowest PMI readings in September, ten were from nations located wholly on the Asian continent, including four of the six countries to register sub-50.0 readings.
The global manufacturing upturn was subdued by supply chain disruptions and material shortages in September. Supply disruptions and material shortages also fed through to higher prices in September. The past six months have seen supplier lead times lengthen to the greatest extents in the survey’s history. Economic activity likely peaked in the summer and will face headwinds due to supply chain challenges over the coming months. But overall, the global manufacturing environment remains in a resilient position.
Outlook for the Canadian dollar
What is it? The Canadian/U.S. dollar exchange rate has typically been driven by two factors: the price of oil as measured by West Texas Intermediate (WTI) and the differential between the two-year yields for U.S. Treasuries and Canadian government bonds. The loonie has always been known as a petro-currency, but over the last decade, the two-year yield differential has also proven to be a highly correlated factor.
Our fair value model would suggest the CAD/USD exchange rate should trade near US$0.87; however, that’s perhaps a bit of an aggressive target, as external factors are limiting its upside. Our six- to 12-month target for the CAD/USD is US$0.81‒0.83.
Typically, when forecasting inflation, the 4 key components are
owner’s equivalent rent
U.S dollar value
price of oil (West Texas Intermediate)
Our inflation model suggests CPI will remain above 2.5% into the third quarter of 2022. We believe higher inflation will put pressure on bond yields and remains one of the key risks worth watching into 2022. We feel that the risk of a recession in 2022 remains low.
To summarize my views for 2022
Yes, things are slowing as we simply cannot continue the growth pace we have seen coming out of the 2020 recession, but what we are entering is called a normalization phase which takes place after a recession. I strongly feel that equities will post positive returns over the next 12 months. Will we see a 20% return? I don't think that is likely. Not impossible but not likely.
However, equities will continue to outperform fixed income during this period. Investors should temper return expectations in 2022 with risk to the upside, however, we continue to experience a strong manufacturing environment which will provide a wonderful backdrop for earnings in 2022. Yes, the year-to-date global market performance has been strong but we would suggest there is still more upside to be had, supported by earnings among other things going in 2022…. And as always, the tried and true principles will once again reward the prudent investor.
Those principles are to take a sound balanced approach and leverage the expertise of actively managed investments that use a tactical approach to take advantage of opportunities when they arise.
For your quick and easy reference...
Here are a few tax-prep numbers to help in planning your upcoming tax documents.
Federal tax bracket thresholds for 2022:
The 33.0% tax rate begins at taxable income of over $221,708, up from $216,511 in 2021.
The 29.0% tax rate begins at taxable income of over $155,625, up from $151,978 in 2021.
The 26.0% tax rate begins at taxable income of over $100,392, up from $98,040 in 2021.
The 20.5% tax rate begins at taxable income of over $50,197, up from $49,020 in 2021.
Income below $50,197 is taxed at 15.0%.
The basic personal amount for 2022 is $14,398 for taxpayers with net income of $155,625 or less. At income levels above $155,625, the basic personal amount is gradually clawed back until it reaches $12,719 for net income of $221,708.
TFSA contribution limit for 2022 remains at $6,000
In closing, we would like to thank you for your trust in Banks Financial. We are always accessible for you so please do reach out anytime with your questions. Always happy to help!
And on a personal note, I hope that you are able to take some time for yourself through the coming holiday season to enjoy the spirit of the season. All my best to you and yours and a very Merry Christmas with Peace, Health and Happiness in 2022!
Roger Banks, RRC