“For auld lang syne, my jo
For auld lang syne.”
Robert Burns, Auld Lang Syne
As another year of COVID-19 domination comes to an end, new strains – both virus and non-virus – are driving decisions.
Omicron, which is more contagious but seems to be less deadly — especially if you’re fully vaccinated — is now the most dominant strain of COVID-19 and has overtaken Delta as a variant of concern. In December, a tsunami of new cases of both strains prompted many governments to re-introduce restrictions to avoid straining healthcare systems. However, these responses are putting a strain on already struggling businesses and sectors of the economy, not to mention family life and mental health.
Actions by Russia and China are straining relationships with the West. Travel restrictions plus unequal access to vaccines are also straining relationships between rich and poor countries.
Inflation was the most significant economic news story of 2021. It was fuelled by supply-chain disruptions, pent-up consumer demand, and the ongoing struggle of central banks to boost their economies while keeping them from overheating. Uncertainty created volatility in both equity and fixed income markets.
Despite everything, 2021 was a year marked by major progress. Canada’s employment now exceeds pre-pandemic levels. Economic recovery has been substantial – government deficits are much lower than expected due to increased revenues. The price of oil, one of Canada’s major exports, rose along with the price of other commodities to give Canada’s economy a boost. Equity markets finished the year on a tear. Globally, GDP growth is expected to be strong in 2022.
We’re doing well thanks to one of the greatest co-ordinated efforts in human history: 9.1 billion vaccine doses have been administered around the world and more than 31.3 million jabs go into arms each day.
Equity markets largely finished 2021 near – or at – record highs. Conversely, a spike in yields (mostly in Q1) caused bonds to finish the year down sharply.
Canada – Markets have been humming
Canada’s first COVID-19 vaccines were administered on December 14, 2020. In just over a year since then, about 80% of our population (five years old and up) has been fully vaccinated and booster shots are rolling out rapidly. Although Omicron is causing unprecedented case numbers in some provinces, an encouraging Ontario public health study has found the risk of hospitalization or death is 54% lower with this variant.
Before Omicron, Canada’s economy was showing continued signs of recovery. In October, GDP grew by 0.8%, and 0.2% in September. Early data point to a strong November, which Statistics Canada said would leave GDP just 0.1% under the pre-pandemic level set in February 2020. However, public health restrictions could lead to lower growth for December and January.
Bank of Canada (BoC) Governor Tiff Macklem stopped calling our 4.7% inflation – which is well above the 2% target – “transitory.” Our central bank has said it expects to start raising rates in the middle of 2022. Yet, with so many variables at play it’s uncertain how long this high inflation will persist, or when the BoC will respond.
For Canadian equity investors, 2021 was very rewarding. The S&P/TSX Composite gained 3.1%, 6.5%, and 25.2% for December, Q4, and the year, respectively. WTI crude started 2021 at US$48 per barrel, climbed to just above US$85 in October, and finished the year at US$74.21. Gold, often regarded as an inflation hedge, declined from US$1,860 per ounce to US$1,829 per ounce by the end of the year, even though inflation was on a definite uptrend. The 10-year government bond yield started at 0.675% in early 2021, peaked at 1.8% in November, and dropped sharply to 143 basis points to end 2021 – despite clear BoC signals that it will raise rates in 2022. For the year, the FTSE Canada Universe Bond Index declined by 2.5%.
U.S. – Omicron but growth
On January 1, 2022, the seven-day rolling average of new confirmed COVID-19 cases in the U.S. was 394,000 according to the highly respected Our World in Data. It was the country’s largest pandemic surge to date; testing is limited, so the case count is likely higher. The Centers for Disease Control (CDC) recently reduced the recommended isolation period to five days, allowing workers to return to their jobs more quickly after becoming infected.
The power of the Omicron strain prompted economists to downgrade U.S. growth expectations for 2022’s debut. Moody’s drastically lowered its Q1 growth forecast from 5.2% to 2.2%. COVID-conscious consumers are changing their behaviour. For example, diners at U.S. restaurants were down 10% for the week ending December 29 versus the same week a year ago, according to OpenTable. Meanwhile, other parts of the economy appear to be operating normally; new claims for unemployment benefits held below pre-pandemic levels for the week ending December 23. Many states and municipalities have opted to avoid large-scale shutdowns. On the other hand, if President Biden’s Build Back Better bill doesn’t pass there will be less government spending to stimulate the recovery.
There was carnage in some high-growth U.S. equities to end the year. Investors became bearish about riskier wagers on longer-term growth stocks and the sustainability of several work-from-home trends. In the pandemic economy, financial technology stocks were among the biggest winners, but lagged at the end of 2021. Higher interest rates on the horizon indicate stocks that price in very high future growth could be adversely impacted. Rising inflation generally prompts central banks to hike interest rates. This has a negative effect on equity prices and an outsized negative effect on technology companies in particular thanks to their higher valuation multiples.
U.S. equities performed strongly in 2021. The S&P 500 gained 28.7% on the year, 11% for Q4, and 4.5% for December.
Europe – No restraining the markets
Since the pandemic’s onset, coronavirus cases in Europe have surpassed 100 million, according to a tally from the Johns Hopkins Coronavirus Resource Center. On January 1, Agence France-Presse reported that Europe logged nearly five million cases in the previous seven days. Of the 52 countries or territories that make up Europe, 17 beat their previous record of most cases in a single week thanks to the highly contagious Omicron variant, the news agency said.
This surge is forcing governments to walk a fine line. They must balance restrictions so that hospitals don’t become overwhelmed while simultaneously keeping economies and societies open. Supply-chain snarls are also adding to economic recovery woes.
In Germany, Europe’s biggest economy, the projected annual growth rate for 2021 is 2.6%, weaker than previously expected. The OECD forecasts an annual German GDP growth rate of 4.1% in 2022.
In December, the Euro Stoxx 50, FTSE 100, and DAX rose by 5.8%, 4.8%, and 5.2%, respectively. Over the quarter, the Euro Stoxx 50, FTSE 100 and DAX advanced by 6.5%, 4.7%, and 4.1%, respectively. For the year, these indices rose by 24.1%, 18.4%, and 15.8%, respectively.
China – Constraints on growth
The world’s second largest economy is confronting obstacles to growth. Its property sector is in distress, supply-chain logjams continue, and consumer spending is down because of COVID-19 restrictions. Steel prices have dropped following lower demand from Chinese construction, and overall demand is expected to decrease in 2022. Property-related sectors are the largest contributor to GDP at 28% for 2021, a decline from a peak of 35% in 2016. Bloomberg forecasts China’s GDP weakened to 4.5% over Q4 of 2021, a decrease from 4.9% forecast in November. Consumer prices were up 2.1% in Q4. A top Chinese government think-tank is recommending that the growth target for 2022 be set at 5.5%, which is lower than 2021’s target.
Next year, China will cut income taxes to aid the middle and lower classes. The Middle Kingdom plans to maintain flexible monetary policy in 2022 to lower financing costs for businesses and aid economic growth.
In December, the Hang Seng was down by 0.3%, while the Shanghai Composite posted a slightly positive return of 2.1%. For Q4, the Hang Seng fell by 4.7% and was down for the year by 11.8%. The Shanghai Composite was up by 2.0% for the quarter and 7.0% for the year.
Japan – Key numbers up
Japan’s factory output for November climbed 7.2% from October, higher than the expected 4.8% increase, as car production and plastic product output were up. Continued semiconductor shortages and Omicron have frustrated growth. Toyota, Japan’s leading automaker, will suspend production in January due to problems created by the pandemic and supply-chain congestion. Manufacturers expect output to increase by 1.6% in December and 5.0% in January.
Japan upgraded its GDP growth projection to 3.2% for fiscal 2022, which starts in April, from its July projection of 2.2%. This would be the economy’s fastest growth since fiscal 2010 and comes on the back of major stimulus measures. GDP is expected to rise by 6.1% for Q4 of 2021. However, Japan’s real GDP growth estimate for the current fiscal year has dropped to 2.6% from an earlier 3.7% estimate. The government believes Japan’s economy won’t recover to pre-pandemic levels until the fiscal year-end next March.
The Nikkei rose 3.6% in December, led by gains in the technology sector. Over Q4, the index fell by 2.1%, and was up overall for the year by 6.6%.
The second half of 2021 showed the wisdom of our diversified and disciplined approach. While we remained tilted toward equities via an overweight target allocation to U.S. stocks, our bond exposure helped protect portfolios when volatility spiked. We continue to believe in the strength of U.S. equities, despite elevated valuations.
Within our equity exposure, we are well diversified by region, capitalization and style. Throughout the year we saw various assets rotate in and out of favour with the markets. By maintaining our diversification discipline, no one factor was dominant in our approach.
Throughout the year, we rebalanced back to our preferred asset mix when market performance dictated. We closed out the year enjoying a strong equity-market rally, and will continue to evaluate our positioning and make trades as needed. With lower sensitivity to interest rates, our fixed income portfolios are well positioned for rising interest rates.
The last word
Entering 2022, it feels a bit like we’re in the same constrained spot as last year. Record COVID-19 cases are prompting restrictions, geopolitical risks abound, and U.S. political parties are battling each other while their own members labour to find common ground. All of us have experienced unusual stresses and strains in our lives.
Although inflation may stick around for a while, some other worries may not. Because vaccination rates are high, at least in affluent societies, hospitalization rates haven’t spiked up till now, as feared. Vaccines are rolling out to more age groups and more of the world’s population. Promising oral drug treatments are coming on stream. Supply-chain constraints seem to be easing and North America’s job market is red hot. Equity markets appear confident they will find middle ground.
As the melodic strains of Auld Lang Syne fade away in the aftermath of our muted New Year’s celebrations, we look forward to a better 2022.
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