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What a difference a year makes!

Quarterly review

Richard Morin

Update :
Update :
January 11, 2023

In December 2021, the policy rate of the major central banks was near 0% and US government bonds were yielding 1.5%, while US stocks were trading at 24 times annual earnings, Canadian residential real estate had risen 28% in 2 years, and Bitcoin was trading at 48,000 USD.

December 2021December 2022
Policy rate0.1%4.3%
10 year bond rate1.5%3.9%
Price / Earnings Ratio24.6x19.2x
Real estate+28% over 2 years-9% since the summer
Bitcoin48 000 USD16 500 USD

As we have said many times, none of these levels or trends were sustainable in the long run. However, no one knew when or how these imbalances would be resolved. The answer to this question was finally provided by the U.S. Federal Reserve in March, when it began an aggressive cycle of interest rate hikes aimed at curbing what had become runaway inflation.

In December 2022, the picture has completely changed. The Federal Reserve's policy rate is 4.3% and U.S. bonds offer a yield to maturity of 3.9% (3.3% in Canada). With all due respect to borrowers (mortgage or otherwise), these rate hikes are good news for investors looking to generate current income.

Stocks have also become more affordable. With prices down 19.9% in 2022, the price-to-earnings ratio of the S&P 500 Index is now near its historical average. Growth stocks (technology and communications, electric vehicles and others) have suffered the most, as investors now prefer value stocks that pay higher dividends.

Canadian investors did much better than others, as the Canadian equity index fell by only 5.8% in 2022, including dividends. In fact, because it is heavily concentrated in oil and resource stocks, the Canadian stock market was one of the best performers among developed markets in 2022. In addition, the rise of the US dollar against the CAD has cushioned the decline in value of US investments for Canadian investors.

Real estate has also started to come back down to earth, down 9% (and nearly 20% in Toronto and Vancouver) after the unbridled rise of the last 2 years. Without making any predictions, it would not be surprising to see this decline continue for some time. For speculators, it's a harsh reminder that real estate can't always go up. For first time buyers, it solves part of the affordability problem, especially if on the other hand their salaries are rising at the rate of inflation.

Although it does not represent an asset class, Bitcoin's 65% decline in 2022 (73% since its peak in October 2021) cannot be overlooked. Bitcoin - like all crypto currencies - has no intrinsic value or economic utility. It is essentially a variant of a Ponzi scheme, supported by a pump and dump operation. Go to the casino instead; at least it's regulated.

This return to normal in the financial markets has caused the value of a portfolio invested 60% in stocks and 40% in bonds to decline by approximately 10% in 2022. Despite this decline, this same portfolio has generated an annualized return of nearly 4% per year (after fees) over the past 5 years. Although it may seem modest - it is indeed well below the historical average - this 4% return corresponds to the standards of assumptions of the Institut québécois de la planification financière. If your financial plan is based on the right assumptions, you have nothing to worry about.

Happy New Year 2023!

Market Review

Asset classesReturn in Canadian dollars
4th quarterYear to date
Canadian Bonds0.10%-11.70%
- Canadian6.00%-5.80%
- U.S.5.90%-12.60%
- International15.50%-9.40%
- Emerging markets8.00%-14.00%

Canadian equities: oil companies lead the way

For the second year in a row, the performance of the oil companies allowed the Canadian stock market to rank among the best (least worst) of the developed countries, down 5.8%.

The energy sector maintained its 2021 momentum, closing the year up 24.4%. It was a rollercoaster year for oil prices. Geopolitical tensions caused by Vladimir Putin's aggression in Ukraine created a shock to global supply, propelling the price of a barrel to over USD 120 for the first time since 2008. However, it has been steadily declining since the summer amid concerns that rising Covid-19 cases in China will slow their economy. It closed the year at USD 75.87.

Like all stock markets, the technology sector suffered greatly in 2022 (-52.2%). Down nearly 75%, Shopify's stock lost almost 175 billion in market value and alone accounts for about 2/3 of the Canadian stock index's decline in 2022. Like others before it (notably Nutrien, Barrick Gold, BlackBerry and Nortel), Shopify's reign as Canada's largest market capitalization will therefore have been short-lived, with the title once again going to the Royal Bank of Canada.

S&P / TSX CompositeS&P 500 (USD)
Consumer Discretionary-8.1%-38.0%
Consumer Staples8.5%-2.8%
Healthcare (including cannabis)-62.2%-3.8%
Information Technology-52.2%-29.8%

US equities: correction needed

The S&P 500 Index was up 5.4% in the last quarter, bringing the decline for the year to -18.1%. Fortunately for Canadian investors, the appreciation of the U.S. currency partially offset this decline, resulting in an annual return of -12.6% in CAD.

Technology and growth stocks - which had been driving the U.S. stock market higher for the past 3 years - suffered a severe correction in 2022. The NASDAQ 100 index ended the year down 33.1%, while the FANGs (Facebook, Amazon, Netflix and Google) all lost between 35% and 65% in value over the past year.

Tesla's stock - which was the 5th largest U.S. capitalization at the end of 2021 - is down more than 70% in 2022. The market is questioning its ability to meet its ambitious growth targets at a time when its boss Elon Musk has a lot on his plate with his recent acquisition of Twitter. As a result, Tesla has been relegated to 15th place among the largest American companies.

The consumer discretionary sector experienced a 38% decline. This sector faced a headwind, due in part to rising labor costs, supply issues, and reduced household spending.

The energy sector - up 58.4% for the year - significantly outperformed the other sectors, but its weight in the S&P 500 (5.2%) was insufficient to offset the decline in the other sectors.

International equities: currencies again

International equities had an excellent last quarter, up 11.2%. They thus beat the US stock market in 2022 for the first time in 5 years (-16.1% for the year vs. -18.1% for US stocks).

Not only did the European stock markets perform well over the quarter (France +11.2%, Germany +14.3% in Euro), but the Euro appreciated significantly after hitting a historic low in September. The mild winter and the drop in oil and natural gas prices have helped to counteract the doom and gloom scenarios that followed Putin's invasion of Ukraine.

The Japanese Yen also appreciated strongly after bottoming out in October against the USD. The announcement of the end of the interest rate control strategy by the Japanese central bank was a factor.

Emerging markets: Covid-19 still relevant

The MSCI Emerging Markets Index returned -14.0% in CAD for the year 2022.

Chinese equities were the best performer of the quarter among emerging markets, up 12.5%. Although the end of the zero-covid policy was a major contributor to this rise, investors remain cautious as the number of cases reaches record levels. China concluded its eventful year down 20.7%.  

It was also a difficult year for Taiwan and South Korea, two exchanges where the technology sector is preponderant, down 22% and 24.9% respectively.

India will be one to watch in the coming years as more and more developed countries include Indian companies in their supply chains. The MSCI India Index is up 18.3% over the past three years compared to a 4.85% increase for the MSCI Emerging Markets Index.

Bonds: Will there be a recession?

The 0.1% return on Canadian bonds during the quarter does not give the full measure of the movements that have affected this market.

Indeed, 10-years bond yield to maturity on bonds first rose to 3.66% in October - amidst fears that inflation would persist - before falling back to 2.75% in early December - as the market feared a recession instead - and finally ending the year at 3.3%.

This volatility in bonds is likely to continue, at least until we know whether central banks will succeed in the trick of curbing inflation without causing a recession. We can still hold out hope, but past experience is not very encouraging: since the Second World War, four out of five rate hike cycles have led to a recession. If a recession hits, we'll be glad to have some Canadian government bonds in our portfolio.