Veritas Market Commentary - January 2022

February 10, 2022 | Vito Finucci


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Why Investing Needs More than a Forecast

We’ve been asked a lot lately where we see markets heading through the end of 2022.  No problem, we reply.  We have just three questions.  Where will the yield on 10-year U.S. Treasuries be at year end?   Will current earnings expectations be met?  And will investors’ relatively bullish sentiment hold up?  Answer these questions and the forecast takes care of itself.   In 2022 though, none of these questions have easy answers, which makes active stock picking all the more critical this year.

Why the outlook is leaning bearish. Earnings estimates are already factoring in strong growth – the current S&P 500 earnings estimate of $220 for 2022 implies 13% year-over-year growth.  If U.S. 10-year Treasury yields hit 2.5% this year (they could go higher), earnings estimates are met, and the equity yield premium over Treasuries remains where it is today (~230 bps on trailing earnings) – then the S&P 500 would be roughly flat at year end at ~4,585 ($220 divided by 2.5%+2.3%) – for a gain of zero versus today.  Any outcome with lower earnings, higher Treasury Yields or a higher equity premium could produce a loss.

Uncertainty is the word … sentiment is the lynchpin:  Earnings estimates are hardly a lock given the likely effects of inflation and wage pressures on corporate margins and growth.  While Treasury yields depend on buyers showing up to the bond auctions, which is not always assured. As a result, we think a lot is now riding on the premium investors are willing to take to stay in equities, which is driven as much by sentiment as investment outlook. 

Will investors be ‘forced’ to remain in equities?  Because equities are still the best hedge against inflation – through their potential for growth – equity premiums may fall even as yields rise.  In the 2.50% Treasury yield example, a 50 bps drop in the equity premium is enough to cushion a 10% miss in current earnings estimates and leave investors slightly ahead (e.g. $198 divided by 2.5%+1.8% = 4,605).  We would still expect gut-wrenching volatility if this scenario were to play out.

Defense matters now more than ever:  While on a macro level, markets may yet pull through to gain in 2022, on a micro level a loss in a single stock can leave a permanent scar on your portfolio.  Consider the math involved – if a stock falls by 50%, it has to rise by 100% in order to get back to even.  And we all know how difficult it is to find investments with the potential for 100% returns. As a result, we think the current environment really favours the defense-first investment approach we use at Veritas’ funds.

Through the end of January 2022, the NASDAQ was down 8.5%, the S&P 500 was down 5.2% and the S&P/TSX was down 0.4%.  Through a careful management of our exposures, our Canadian Equity Fund rose 1.0% in January and our Absolute Return Fund was up 2.2%.  (Performance based on F series).  We continue to navigate this year’s markets with a careful eye on risk.

As always, the team at Veritas Investment Research is providing us with valuable fundamental and accounting-based insights to action in our funds.  Veritas’ calls have outperformed in all types of markets over the last two decades, demonstrating the enduring value of independent thinking and analysis.

We thank you for your continued support.

Your fellow investors,
Anthony Scilipoti & Sam LaBell

 

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