“It is a mistake to think that moving fast is the same as actually going somewhere.”
Steve Goodier
On the eve of the Olympic Winter Games this month in Beijing, The New York Times asked elite athletes what scares them most. They replied that their biggest fears were “getting hurt, performing new tricks, bad weather, uncertainty, and skiing nearly blind.”
In January, most of us also had elevated levels of anxiety. Our fears were focused on two major world themes: COVID-19 and Russia’s intentions toward Ukraine.
At January’s end, the Omicron variant was largely responsible for 500,000 new U.S. cases and 1,000 deaths per day. Pandemic lockdowns and mandates continued to create fallout. Ongoing cargo congestion and labour shortages aggravated inflation.
Geopolitical tensions between East and West continued on a low boil, stoked by President Vladimir Putin’s bellicose language and his massive troop build-up on Ukraine’s eastern border.
Meanwhile, bond and equity markets are acutely focused on the world’s central bankers, reacting to each word they say – or don’t say. The big questions: when, and by how much, will they begin hiking interest rates?
Both the Bank of Canada (BoC) and the U.S. Federal Reserve have promised rate hikes, most likely beginning in March. BMO Economics currently estimates that both will raise rates 125 basis points in 2022. Unrelenting inflation is driving central banks to escalate their hawkish comments, which caused significant intra-month volatility. Growth-oriented stocks, in particular, are struggling because a greater percentage of their valuations are tied to future cash-flow growth.
Canada – The wait continues
Many regions of Canada welcomed 2022 as they welcomed 2021 – once again under capacity restrictions designed to keep our healthcare systems from being overwhelmed. However, January brought positive news as well. Restrictions loosened as our economy started to reopen. The World Health Organization announced new recommendations for countries to lift or ease COVID-19 travel restrictions.
Strong domestic and foreign consumer demand pushed inflation higher. Continued supply-chain snarls and labour shortages drove up prices. The BoC now estimates inflation will hit 4.2% this year, up from its October forecast of 3.4%, and well above its 2% target. But it also expects inflation to drop back down to 2.3% in 2023. Trying to tame inflation while grappling with pandemic unknowns, our central bank held the overnight rate at 0.25%, while making it clear that rate hikes are coming. Economists expect five hikes this year and more in 2023.
After reaching an all-time high in December, the S&P/TSX retreated 0.4% in January. Canada’s main stock index declined less than most other equity markets thanks to strength in our energy sector. Oil’s tight supply and falling inventory drove WTI from US$75 to US$88 per barrel. Gold prices responded to market volatility more than inflation expectations. The yellow metal went from a high of US$1,850 per ounce to fall below the psychologically significant level of US$1,800 per ounce. The 10-year government bond yield responded to the BoC’s signals it won’t keep a lid on rates much longer and jumped from 1.43% to 1.77% this month.
United States – Talk but no action
The U.S. economy boomed at an annualized pace of 6.9% in Q4 2021 and 5.7% for all of 2021 – the strongest growth since 1984. Consumer spending in 2021 soared by 7.9%, the fastest pace since 1946. While these readings were more muscular than most analysts had predicted, the growth tempo is likely to moderate through the first half of 2022.
The U.S. Federal Reserve is set to begin a cycle of rate hikes to combat high inflation. Omicron has threatened both supply chains and employment, and volatility has spiked in equity markets. The main engine of GDP growth is consumer spending – that got a boost from both monetary and fiscal stimulus in 2021. Now COVID-19 relief programs have largely ended, and consumer savings are beginning to slip from record highs. Borrowing will become more expensive for businesses and consumers as the Fed acts aggressively. All of these factors prompted the World Bank to forecast that the U.S. economy will expand by a more leisurely 3.7% in 2022.
Many European and Asian nations have rolled back pandemic protocols, eager to declare victory over the virus. In contrast, at the end of January, all U.S. counties were classified as high transmission.
On the geopolitical front, there is a “distinct possibility” Russia could invade neighbouring Ukraine, President Biden said. U.S. and NATO allies are preparing to respond if Russian troops advance. The West has vowed swift and strict economic consequences if a diplomatic resolution can’t be reached.
After hitting all-time highs as 2021 drew to a close, U.S. equities retreated in January. The tech-heavy Nasdaq plummeted 9.0% and the S&P 500 declined 5.2%.
Europe – What’s the rush?
Eurozone inflation rose to a fresh record of 5% in December. European Central Bank (ECB) chief economist Philip Lane said the ECB would tighten its policy if inflation remains above target. However, inflation is expected to drop below that level in January and the central bank expects it to come back under its 2% target in 2023 and 2024. The ECB will meet in early February to discuss policy, but is not expected to make changes. In December, it said the US$2.09 trillion pandemic stimulus will wind down by the end of March.
In January, the Euro Stoxx 50, FTSE 100 and DAX returned -2.7%, +1.1% and -2.6%, respectively. Markets remained volatile amid worries about the direction of central bank policies and rising tensions over Ukraine.
China – Full speed for stimulus
While the central banks of most other regions are in a monetary tightening mode, the People’s Bank of China is providing more stimulus to stabilize the economy. In January, it cut borrowing costs on medium-term loans by 10 basis points and the five-year prime loan rate by five basis points.
China rebounded in 2021 with GDP growth of 8.1%, its best performance in a decade. GDP in Q4 grew 4.0% on a year-over-year basis, which was higher than expected but still the slowest growth since Q2 of 2020. China’s tumultuous property sector and strict protocols for COVID-19 outbreaks were to blame for a slackened pace.
Net exports accounted for more than a quarter of Q4 GDP growth. Increased sales abroad to economies impacted by COVID-19 gave China its biggest trade surplus since 1950, the year it began documenting numbers. Support from export growth may not last – the surge in overseas demand for goods is easing and high costs are putting pressure on exporters. On a positive note, industrial output rose by 4.3% annualized in December, up from a 3.8% increase in November and higher than the 3.6% increase that Reuters forecast.
In the final week of January, China detected 119 COVID-19 cases among athletes and staff involved in the Beijing Winter Olympics. Authorities implemented a “closed-loop bubble” to separate those involved with the Olympics from everyone else in the city. Thousands of athletes, coaches, officials, reporters, trainers and select guests are expected for the Olympics, which run from February 4th to 20th. China has built a wall around itself with a zero-tolerance COVID-19 policy, cancelling nearly all international flights in a Herculean effort to prevent the virus from spreading and prepare for an influx of foreigners.
In January, the Hang Seng returned 1.7% while the Shanghai Composite was down 7.7% for January.
Japan – A bumpy performance
In December, Japan’s factory output shrank for the first time in three months, falling 1.0%. Automakers haven’t been able to keep up with demand due to chip shortages and competition for semiconductors from consumer electronic companies. Toyota expects production to fall short of the annual target of nine million vehicles for the business year ending in March. In a government survey, manufacturers said they expect output to grow 5.2% in January and 2.2% in February.
December retail sales posted their third straight month of year-over-year gains at 1.4%. On the other hand, record Omicron infections through January are expected to dampen consumer sentiment. To manage case numbers, regional governors have the option of imposing shorter business hours on restaurants and setting rules for serving alcohol. These measures currently cover about 70% of the country and will run until February 20.
The Nikkei fell 6.2% in January, with large technology names dragging down performance as they did in other geographies. Investors are concerned about the economic outlook following U.S. signals that rate hikes are approaching.
Our strategy
Earlier this month, we trimmed equity exposure in portfolios that had moved somewhat above our tactical overweight equity targets. Where appropriate, proceeds were generally directed to money market and alternative fixed income solutions. While this trade has clearly been beneficial, we may reverse course if equity market declines create sufficient value and we find opportunities to capture.
The last word
The course for rate increases (and even quantitative tightening) is set, but it won’t be a linear path. We can expect the unexpected when it comes to all the variables that could potentially influence – and even surprise – central banks. Various asset classes and factors will move in and out of favour as we navigate through this unprecedented period. We will remain disciplined and diversified, but will make adjustments to portfolios as warranted by market environments and auspicious opportunities.
Bank of Canada Governor Tiff Macklem, U.S. Federal Reserve Chair Jerome Powell and their global counterparts have an unenviable task. They must manage inflationary pressures yet avoid everyone’s worst fear of stifling economic recovery. We are carefully monitoring their progress.
Information contained in this publication is based on sources such as issuer reports, statistical services and industry communications, which we believe are reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions only and are subject to change. BMO Private Wealth accepts no liability whatsoever for any loss arising from any use of this commentary or its contents. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice, tax advice, a recommendation to enter into any transaction or an assurance or guarantee as to the expected results of any transaction.
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