To my clients:

It was an up week for North American stock markets, with the Canadian TSX finishing up 1.3%; the U.S. Dow Jones Index up 4.0%; and the U.S. S&P 500 up 3.8%.

With this week’s strength, markets have largely recovered most of the recent Omicron inspired weakness. While I don’t believe “we” are out of the woods with respect to Omicron, it appears evident that this new variant also won’t be the worst case scenario many feared upon its discovery. But I’d still like to see a bit more data before reinvesting the cash raised from the modest defensive measures taken two weeks ago. Such data should be available within the next week or two.

Moving on, what might 2022 hold? Here are some high level observations I thought I’d share.

My and RBC’s underlying view for 2022 is that it will be a year marked by some moderation in trends. Rising levels of covid vaccinations and natural immunity, combined with less morbidity from variants that are likely to remain in circulation, should gradually lead to a more normal environment. More specifically, I’d expect some reversion in some of the most influential factors that typically drive equity (i.e. stock) returns: inflation, growth, and central bank support.

Let’s begin with inflation. Data released this morning showed a near 40-year high in headline inflation, while “core” inflation (stripping out food and energy costs) rose to 30-year highs. These elevated levels recently motivated the U.S. Fed to “retire” the word “transitory” from their lexicon when describing inflation. Further, the Fed has almost assuredly been inspired to speed up its “taper” process whereby it reduces the amount of asset purchases it makes on a monthly basis with the prospect that these purchases will taper to 0 as soon as April or May of next year – many months earlier than previously guided. The official announcement of an expedited taper timeline will likely come as soon as next week at the next Fed meeting. So inflation has caught the Fed’s attention. However, I’d argue that it couldn’t be seen to do nothing and that, to a certain extent, this expedited taper process appears as much about optics as anything else. A huge chunk (nearly 40%) of the elevated inflation reading emanates from increased automobile prices which, in turn, stems from parts shortages – most notably computer chips. There are already signs that these shortages are beginning to ease. Further, we must again remember that inflated 2021 prices are in comparison to depressed 2020 prices. When 2021 annualized price increases are instead compared to pre-pandemic 2019 prices, inflation metrics return to near normal levels (admittedly, still elevated, but only slightly so).

What about the economy and GDP growth? This too should moderate in the year ahead. While 2021 is not yet complete, many major economies saw growth near the mid-single digits this past year. That’s a relatively big figure, particularly for the developed world, and meaningfully higher than the low single digits seen prior to the pandemic. Meanwhile, earnings growth from companies around the world was abnormally high. Like inflation, much of the strength was the result of a rebound in 2021 earnings in comparison to depressed 2020 levels. But, growth next year still has the potential to be above average. Economies have yet to fully reopen in a synchronized way; production has been limited due to supply chain issues; inventories remain historically low and need to be rebuilt; and households have high savings and may be eager to spend. All this suggests that growth will look more normal, but has the potential to be at the high-end of “normal”.

Lastly, central banks have started to unwind some of the exceptional amounts of stimulus provided to economies over the past two years (see, for example, my note on the Fed’s likely acceleration of the “taper” process above). Barring a worst-case scenario of a vaccine immune covid variant that leads to dire health outcomes, the future direction of central bank is clear: less stimulus and the possibility of higher interest rates in the year ahead. While this may create some bouts of volatility as investors digest the implications, it will take time and several interest rate increases before credit conditions become more restrictive and present a headwind to economic growth. That is more likely a risk for 2023 or 2024 rather than next year.

Bottom line: 2022 looks set to be a generally positive year for the economy and markets. However, as central banks begin to more aggressively adjust their monetary policies in the face of this anticipated strength, clients should be prepared for uncomfortable bouts of volatility. But, as I’ve always argued, unless a credible threat of recession emerges, clients are encouraged to look through this volatility as best they can. At this juncture, no such credible threat is evident in any of the economic data.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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Any recommendations herein are for the exclusive use of clients of RBC Dominion Securities and Investment Advisor Nick Scholte. Any other direct or indirect recipient of this email should consult with his/her own licensed investment advisor prior to implementing any investment action he/she may be contemplating.