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To hell with the pandemic!

Quarterly review

Richard Morin

Update :
Update :
January 19, 2022

4th Quarter 2021 Review

Against all expectations, the world's stock markets had an excellent year in 2021. The Canadian stock market is up 25.1% and the S&P 500 index of the American stock market is up 27.7% in CAD, including dividends.

Table Asset classes performance

Since their pre-pandemic highs in February 2020, the Canadian and US stock markets are up 39% and 45%, respectively. As for the misguided investor who liquidated his or her equity portfolio at the bottom of the wave in March 2020 - and has remained on the sidelines ever since - he or she has missed out on returns of 99% in Canada and 119% in the United States.

How can we explain the performance of the stock markets when the world is experiencing its worst health crisis in more than a century and when, intermittently, entire sectors of the economy have been paralyzed for the past two years? Two major factors have contributed to this performance.

Corporate profits

Ultimately, it is the ability of companies to generate profits now and in the future that determines the value of their shares on the stock market. The estimated profits for 2021 for S&P 500 companies are 26% higher than those for 2019. And that's not even counting the astronomical estimates of future profits in certain areas such as technology and electric vehicles (e.g., Tesla).

What was not understood in March 2020 is that - although the pandemic is a calamity for many service companies - consumers are reallocating their spending budgets en masse to purchases of goods. It is this sudden increase in demand for all kinds of consumer goods that is causing inventory shortages and a resurgence of inflation, and boosting corporate profits.

S&P 500 Profits Histogram

Support from governments and central banks

Governments and central banks have joined forces in 2021 to help households and businesses get through the health crisis and periods of containment.

While governments have taken on a lot of debt - the Government of Canada has spent tens of billions on support for households and businesses - paradoxically, many consumers have ended up with more money than they had before the crisis. In fact, according to The Economist, Americans have accumulated 2.5 trillion more since the start of the pandemic than they would have in normal times. Since it is difficult, if not impossible, to spend all this money on outings and trips (except for a few Ostrogoths flying to Cancun!), they are buying skis and snowmobiles instead, but also speculative securities listed on the stock market and cryptocurrencies.

In turn, central banks have kept their policy rates very low and purchased government bonds, thereby reducing interest rates and borrowing costs.

All this money injected into the economy and the financial system by governments and central banks has to go somewhere. In addition to buying consumer goods, much of it has been invested in the stock market, real estate and cryptocurrencies. Americans have in fact pumped more than 1 trillion into equity funds in 2021, an all-time record. Canadians are not to be outdone, having made net purchases of mutual funds and exchange-traded funds of over 160 billion.

Low borrowing costs and the desire to live in a larger home, in a world where telecommuting is becoming the norm, has also pushed home prices up sharply. In turn, this increase in the value of their homes has created a sense of wealth among homeowners that has undoubtedly prompted many to consume and invest even more.

As for cryptocurrencies, when a non-fungibleBored Ape NFT token sells at auction for 2.5 million USD, it's starting to heat up!

All good things must come to an end

We'd love to keep the party going, but all good things must come to an end, and governments and central banks must start weaning the economy off these support measures before inflation and budget deficits get out of control.

Central banks have taken the first steps. They have stopped buying bonds or are in the process of doing so. They also plan to start raising interest rates in 2022.

Anticipating these announcements, markets began to react, particularly in sectors where overheating was apparent. Among the first victims of this paradigm shift, the ARK Innovation fund - the poster child for the pandemic, which invests in disruptive innovation - is down nearly 50% since its peak last February. More recently, it was Bitcoin's turn to suffer the backlash, having lost about a third of its value since early November.

ARK Innovation Graph
Bitcoin Chart

In 2022, we could hear as much about central banks as about coronavirus. That will change the pain of the place!

Market Review

Canadian Equities: Oil & Finance

The energy and financial sectors alone account for 45% of the capitalization of all companies listed on the Canadian stock market. As these 2 sectors did very well, our stock market ranked among the best in the developed world in 2021 with a return of 25.1%.Fully recovered from its existential crisis of 2020, oil rose by 55% in 2021, to 75 USD a barrel. This is good for oil companies' profits and their stock market shares. Environmentalists can take solace in the fact that the more expensive oil becomes, the more economically viable it becomes to develop clean alternatives. The energy sector generated a 41.8% return in 2021.

The banks also had a strong year as a result of increased consumer credit and mortgages, lower than expected loan losses and a good contribution from their capital markets business. These strong results allow them to resume increasing their annual dividend. The finance sector is up 32.8% in 2021.

Gold has once again proven that the so-called protection it offers against inflation is a myth. The yellow metal is down 4% while inflation is at its highest level in 4 decades. The price of all other major materials has risen sharply in 2021, as evidenced by the 38.5% rise in the CRB All Commodities Index. Were it not for the decline in gold, the materials sector would have done much better than a meager 2.3% gain in 2021.

Table Sector and yields

US equities: a market dominated by tech

The S&P 500 Index of U.S. large-cap stocks had another strong quarter, up 10.1%, bringing the annual return to 27.7%. The best sectors were energy and real estate, up 47.7% and 42.5% respectively, but they do not weigh enough in the index to be a factor in overall performance.

Recovering from itsQ3 underperformance, it is instead technology (which makes up 29% of the index) that has pushed the S&P 500 higher with a 33.4% return on the year. Among the tech heavyweights, Nvidia's stock more than doubled in 2021, while Microsoft and Alphabet (Google) are up 41% and 56% respectively.

This excellent performance by the main stocks in the index hides a more nuanced reality. Indeed, while the S&P 500 was sailing towards new highs, in mid-December, 334 stocks listed on the New York Stock Exchange were trading at their 52-week lows, twice as many as the number of stocks setting new highs.

International equities: still far behind

As in 2020, international equities have not been able to keep pace with US equities. In fact, for the past 5 years, the annual return of international equities has been half that of US equities (8.4% vs. 16.6% in CAD).

There is no need to look for the difference in performance: technology stocks weigh three times more on the American stock market (29% of the market) than on international stock markets. There is no French Microsoft or Alphabet!

That said, international equities still generated a 10.4% return in CAD during 2021.

UK stocks contributed the most to performance. Its economy grew the fastest among G-7 countries in 2021 (6.9%) and is expected to continue to lead in 2022. The British pound maintained its value against the CAD.

The same cannot be said for the Euro and the Yen, which have depreciated significantly against the CAD, which has eroded returns for Canadian investors. The Japanese stock market in particular - which accounts for nearly 25% of the international stock market index - has seen its 13.4% return in 2021 almost entirely wiped out by the decline of its currency against the CAD.

Emerging markets : China vs. Taiwan

Taiwan is constantly being intimidated by China, which would like to take control of what it considers a rebel province. In the meantime, however, it is the Taiwanese stock market that has been thumbing its nose at the Chinese, with a 25.1% rise in CAD while Chinese stocks lost 22.4%. Unfortunately for us, China accounts for 36% of the index compared to 14% for Taiwan. As a result, emerging market equities lost 1.1% in CAD terms over the year.

In addition to Taiwan, the performance of the Indian stock market in 2021 should be mentioned, up 25.2% in CAD. Technology (notably Infosys, with a market capitalization of USD 108 billion), materials and industrials sectors generated the bulk of the return. India had a record year for the number of companies going public and benefited from the influx of foreign capital from China.

Bonds: relatively stable rates

Interest rates on 10-year Government of Canada bonds fell slightly during the quarter. However, at 1.43%, they remain within the 1.35% to 1.80% range since March. This slight drop in rates explains the 1.5% return on the bond portfolio for the quarter. For the year, the return is -2.5%.

The year 2022 will be a test for the bond market. As central banks cease their bond-buying program and even begin to sell the bonds they hold, we will see what the real appetite is among investors - institutions and individuals alike - for this insurance policy against bad times.