DHG Outlook 2022 - Dekker Hewett Group
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DHG Outlook 2022
In 2021, the world returned to normal: Restaurants were full,
cross border travel flourished, and masks were a thing of the
past. Not quite. From 30,000 feet, the COVID lockdown and
re-opening can most easily be summarized as 2-steps
forward, 1 step back. With respect to global economies, that
was somewhat more predictable: GDP collapsed in the first
half of 2020, then exploded in the third quarter, followed by
strong, but erratic, quarterly growth ever since. The fourth
quarter data, when it’s released in January, will show 2021 had
the fastest GDP growth, and highest inflation, since the 1980s.
In an ironic and twisted fate, Covid-19 proved to be a positive
catalyst for the stock market as an unprecedented amount
of stimulus has been injected into global economies. One of
the things that the pandemic has underscored more than
anything else is that the stock market is a forward-looking
mechanism. That’s been the tagline all year long as investors
continue to scratch their heads wondering why the stock
market could perform so strongly while the economy, labor had smaller maximum drawdowns. Meanwhile, the S&P 500
market and earnings continue to navigate a global pandemic. tied a market record of seven consecutive months without
It’s more about future expectations than current conditions. a 5% or more pullback. Looking at the largest intra-year
It’s something that investors have always been aware of S&P 500 drawdowns, only 1995, 2017 and 1993 had smaller
but was certainly front of mind in the last 20+ months. The pullbacks. Despite the continued headlines of doom and
market appears to be largely focused on the prospects of a gloom, 2021 was an incredibly tranquil year from a volatility
brighter outlook driven by vaccine rollouts, even as recent perspective, supported by a strong economic recovery and
coronavirus trends continue to worsen and restrictions in very accommodative monetary policy. The TSX reached an
activity are reimposed. impressive 62 record highs this year, the most since 1996.
Meanwhile the S&P 500 saw 72 record highs, a handful shy of
Even though there were a few market twists and turns, 2021 the 77 record set in 1995.
gave investors the best of both worlds: plenty of upside, with
most major indexes achieving strong double-digit returns, and Looking forward, 2022 is likely to prove more challenging, but
limited downside, with infrequent and short-lived pullbacks. the outlook remains positive, in our view. For one, this year is
In fact, 2021 joined an elite club of years without a pullback likely a mid-cycle year for our economy and historically stocks
larger than 5% in the TSX. For the TSX, only 2019 and 1993 during these years have been higher 80% of the time and up
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11.5% on average. In fact, only twice out of 30 years did stocks 3% (the Bank of Canada’s upper range) for eight straight
ever drop more than 10%. months, with the November reading coming in at 4.6%.
Amid material and labor shortages, supply has struggled
Here we highlight five themes that drove markets in 2021 and to keep pace with the rapid rebound in demand for goods,
what this means for potential implications in 2022. driving prices higher.
1) T
he economy grew at its fastest pace in more than 2022 IMPLICATIONS – Inflation will be front and center as
two decades. central banks gear up toward rate hikes to tame fast-rising
prices. We expect that easing in supply chain bottlenecks
• It was powered by massive fiscal and monetary stimulus, a
and the shift back to services from goods will help inflation
vaccine rollout and pent-up consumer demand. Canadian
GDP likely grew ~5% in 2021, the fastest pace since 2000. peak in the coming months and moderate from there.
With the benefit of strong household consumption, which Also, we don’t anticipate a repeat of last year’s surge
makes up 60% of the economy, economists forecast that in energy prices. However, because of signs that price
economic activity will likely reclaim its pre-pandemic peak in pressures are broadening (rent increases, rising wages),
the first quarter, a remarkable achievement considering the we think inflation will stay above the Bank of Canada’s 2%
depth of last year’s recession. long-term target through this year. In our view, one of
• H
ousehold finances emerged from the crisis in better shape the best hedges to inflationary pressures is to invest in
than they went into it, courtesy of government support equities, which tend to outpace the rate of inflation over
and a rising stock market and home prices. Spending on time. Consider just last year, for example: While inflation is
big-ticket items surged, pushing goods consumption well up 6.2% year-over-year, the S&P 500 was up roughly 25%.
above its pre-pandemic trend. On the other hand, spending Diving into the equity component a little deeper: In a rising-
on services is still trying to recover amid the ongoing inflation and rising-rate environment, value and cyclical parts
pandemic. of the market tend to outperform, including sectors like
• U
nemployment declined from 9.4% at the beginning financials, energy, materials, and industrials.
of the year to 6.0% in November, achieving in one year
what took almost 10 years in the last expansion (2009 3) The US Fed began to taper, and the market had a
to 2019). As the year ends, there are increasing signs of mini-tantrum.
labor market tightness, with job vacancies exceeding the
number of unemployed. • E
arly in December the US Fed announced an accelerated
balance-sheet tapering process: The pace of tapering will
2022 IMPLICATIONS – Given the atmospheric rise, growth increase from $15 billion per month currently, to close to
will likely moderate from last year’s rapid pace to about $30 billion per month. This would allow the Fed to wind
3%-4%, but this is still considerably above the 2.2% average down its tapering process by the first quarter of 2022, which
over the last decade. Even though stimulus is already in the would place Fed policymakers in a position to raise interest
process of being wound-down, consumers saved a good rates — their more traditional and more powerful tool —
portion of the government income they received, sooner, and if needed. That’s consistent with the futures
and further job gains will continue supporting incomes. market for federal funds, which appears to be pricing in two
A full return to normalcy, though difficult to time, is likely or three rate hikes in 2022 (assuming the rate hikes are 25
to unleash pent-up demand for services such as travel and basis points each). We were also of the belief the economy
could handle both a faster taper and earlier rate hikes.
entertainment.
Remember, even when it’s tapering, the Fed is still expanding
its balance sheet, it’s just doing so at a slower rate.
2) A
fter almost four decades of hibernation, inflation made
a comeback as strong demand met constrained supply 2022 IMPLICATIONS – There’s a lot of discussion as to why
stocks are rallying given prospect of rate hikes being pulled
• 2
021 has been the year of high prices and inflation forward, but the reality is equities have historically done well
surprises. The consumer price index (CPI) has topped
leading into Fed rate hikes (left panel).
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fold. Individuals who had sat out Wall Street’s more than
a decade-long winning run jumped into stocks this year,
lured by a trading mania that had hundreds of thousands of
investors buying into struggling old-school companies like
cinema chain AMC Entertainment and video game retailer
GameStop as both became fodder for online chat rooms.
• I t was also the year of SPACs. The funds raised via U.S.
special purpose acquisition companies have totaled a
record of $162 billion in 2021, almost doubling the $83.4
billion issuance last year. SPACs raise capital in an initial
public offering and use the cash to merge with a private
company and take it public, usually within two years.
• T
he market was red-hot in the first quarter with new deals
recording an average 6.5% first-day jump. Small-time
investors represented 46% of trading volume in SPACs on
Bank of America’s platform in January. Now the industry
has cooled down amid a multitude of challenges, spanning
from regulatory pressure to the prospect of higher
interest rates and to the increasingly competitive
4) Welcome to the year of SPAC and “meme stocks” deal-making environment.
• S
ince 2020, the stimulus from central banks has helped
maintain stability in the credit system by lowering borrowing 2022 IMPLICATIONS – We expect real yields (after inflation)
costs for consumers and businesses. However, this excess to rise from near-record lows. The gradual removal of excess
liquidity – or cheap money – revived “animal spirits” that liquidity and rate hikes will likely spark bouts of volatility in
often emerge in a strong bull market and found its way into the frothier segments of the market. We don’t think these
certain risk assets. This year’s activity coincided with a surge speculative areas represent a systemic threat, but we see
of rookie investors who joined the world of stock trading to investor sentiment and positioning as headwinds heading
ride the historic market rebound. Remote work, stimulus into the new year. As the bull market progresses, a focus on
checks and higher personal savings levels, as well as social high-quality investments and diversification across asset
media chatrooms only accelerated the boom in retail
classes becomes more important.
trading.
• T
he 2021 rush to heavily shorted “meme stocks”
accomplished at least one thing where the longest bull
market had failed: It brought young retail investors into the
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a year ago, up 22.3% versus the pre-COVID peak at the end
of 2019, and currently at a record high.
• W
ithout getting too technical, the key variable in this
equation is what discount rate should we use? If we use
1.50%, roughly the current 10-year Treasury yield, the
model suggests the S&P 500 is grossly undervalued. But,
with the Federal Reserve still holding short-term interest
rates at artificially low levels, the 10-year yield might be
artificially low, as well. So, to be cautious, market strategists
can plug-in higher long-term interest rates. Using third
quarter profits, it would take a 10-year yield of about 2.75%
for the model to show that the stock market is currently
trading at fair value. And that assumes no further growth in
profits. Now, nobody is expecting the US 10-year to finish
2022 anywhere near that level. Rather, some economists
5) R
ising corporate earnings drove earnings power which expect the 10-year Note yield to finish 2022 in the vicinity
of 2.00%. Nonetheless, looking at a more conservative
moved markets higher.
discount rate of roughly 2.50% and using third quarter 2021
• T
he TSX finished the year near record highs, up about 22%. profits, that creates a fair value estimate for the S&P 500 of
This ranks sixth in annual price gains over the last 35 years. 5,250. And this does not take into account higher profits in
A key underpinning behind this hefty market return has the year ahead.
been the strong cyclical rebound in corporate earnings,
which has more than offset a small decline in valuations. 2022 IMPLICATIONS – We estimate the bull market moved
The abundance of economic growth drove corporate from the early recovery phase to a mid-cycle phase this
revenue higher, and pricing power along with productivity past spring. As it progresses further into this phase, the
improvements helped margins (profitability levels) reach a pace of earnings and market gains will likely slow, but a still-
record high. strong demand backdrop will continue to support earnings,
• W
e often tell our readers that we stick to fundamentals: helping sustain the bull market.
Assessing fair value by using economy-wide profits and Putting it all together, we expect real GDP to rise at about
interest rates – often called the Capitalized Profits Model. a 3.0% rate in 2022. Why slower than 2021? Because 2021
The Capitalized Profits Model takes the government’s was artificially boosted by big deficit spending and we were
measure of profits from the GDP reports, discounted by still recovering off a low base. For inflation, it looks like the
the 10-year US Treasury note yield, to calculate fair value. Consumer Price Index will be up in the 6.5 - 7.0% range for
Corporate profits for the third quarter were up 20.7% versus 2021. The consensus among economists is that will slow
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to 2.7% next year, but don’t be surprised if inflation will run Good fundamentals aside, here’s more historical evidence that at 3-4.0%. For the job market, look for solid job growth to would support a bullish thesis. Big years in which the TSX was continue. Job openings remain plentiful and, slowly but surely, up over 20%, such as 2021, have seen the following year higher some of the people who have left the labor market should get 62.5% of the time and up +6.9% on average. Being outdone pulled back in by rising wages. Look for the US to add 325,000 by our neighbours to the South, years in which the S&P 500 – 350,000 jobs per month next year. For the market, we think was up more than 20% saw the next year higher 85% of the investors should prepare for positive, but more muted gains in time and up a solid 11% on average. In other words, we have the coming year. A slight contraction in the price-to-earnings fundamentals, technicals, and history suggesting 2022 should multiple (valuation) from current elevated levels; positive but be another good year for investors. slower earnings growth, as profit margins recede from record highs amid rising labor and input costs; and a steady dividend yield supports our outlook for upper single-digit returns for the TSX and S&P 500 in 2022. cgf.com
Dekker Hewett Group
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