12 Themes for 2022
Insights from our Calgary Office
Every year, we gain experience and wisdom and hope to pass on the fruits of such to our clients through our asset allocation decisions for your respective portfolios. Each of our themes is a key element within the market landscape that we believe will be relevant to your portfolio and its potential returns over the upcoming year. We hope you find them thought-provoking and an interesting read.
In no particular order:
- Favour Companies with Pricing Power
While many politicians and central bankers would like us to believe that inflation is transitory, there is every reason to believe that inflation will remain somewhat elevated well into 2022. Consequently, we think we as investors should focus on companies that can increase prices at a faster rate than their costs are rising. This allows these companies to have their margins increase, or at least be maintained. Furthermore, if some of these inflationary pressures subside at some point, these companies may also be able to maintain their prices even while their costs decline. This would lead to further margin expansion. We will maintain a bias towards value and cyclical stocks at this phase of the economic cycle.
- Don’t Forget About Copper and Oil
For much of the last decade, investing in many commodities has been a difficult experience for investors and many investors have exited these sectors entirely. However, after years of underinvestment, supply of commodities such as copper and oil are tight and the lead time on large projects (to increase supply) is often many years. If we continue to see COVID-related hospitalizations decline, we would also expect to see the economic expansion continue and demand for transportation and travel to increase. These conditions should result in higher demand for commodities such as oil and copper. Higher demand and tight supply are the textbook conditions for higher prices.
- Short Duration Bonds for the Win
To preserve capital and lock in yields, low coupon corporate bonds under 3 years will help reduce volatility in a rising rate environment (especially when Bank of Canada gets closer to and during liftoff).
- Capital is at Risk if you hold to Maturity
We will be actively realizing gains on our premium bonds because in a rising rate environment, capital losses will be permanent as yields increase and bond prices decline faster than in a stable rate environment. Given bonds mature at par, recovery of capital will be unlikely.
- Single Family Housing Strength Doesn’t Stop
From 1985 until today the United States has had 226,000 detached single-family homes started per quarter. Pre global financial crisis, this grew to nearly 400,000 per quarter, leading to an estimated 2 million homes being overbuilt. This naturally led to an over correction the other way, having only 160,000 homes started each quarter since 2010. Reversing the 2 million overbuilt homes to being nearly the same amount underbuilt. Late 2019 was the first year that new builds exceeded the long-term average. Housing cycles can last from five to fifteen years and given the current lack of supply, there is a possibility for housing to perform above its historical average, late into this decade.
- Liquidity continues to dry up
Since the beginning of the pandemic, central banks around the world have gone into full accommodation mode to try to support the financial markets. As of the end of November 2021, the US Federal Reserve has printed $4.5 trillion for the use of quantitative easing (buying government bonds) which has created an unprecedented amount of liquidity in markets. While participants quibble over whether this is inflationary, the reality is that this has been undeniably bullish for risk assets of all varieties. A rising tide lifts all boats and the boats that are most unfit for sea typically tend to rise the fastest in this type of environment. 2022 projects to see a diminishing liquidity environment with tapering of the quantitative easing process to zero by mid-year and the possibility of three interest rate hikes. We expect this diminishing liquidity environment to see capital appreciation to be more difficult to achieve with more fundamental work required with asset selection. In addition, we would expect a lot of those non-sea-worthy boats to really struggle.
- Tail-end risk protection
As of this writing, the US 10-year government bond is yielding 1.45%. Not only is this not keeping up with most inflation measures (leading to a negative real return) but if we see major volatility, you’re not going to see government bonds buffer your portfolio volatility as much as they have historically. The good news is the advent of ETFs has led retail investors to have more exposure to what had historically been reserved for sophisticated institutional investors with billions under management. The need for long volatility strategies has become more common, especially as we continue to exist in this negative real interest rate world. As these products become more available and more tested, we would expect these types of vehicles to become more prevalent in an investor’s portfolio.
- Non-Profitable Covid Beneficiaries Will Continue their Disappointment
2021 has not been a kind year to the next generation Covid beneficiaries. Post the February meme stock explosion, the Goldman Sachs Non-Profitable Tech Index has fallen from 446 to 275 (down 38% on an absolute basis) lagging the S&P 500 by 47%. As per Bloomberg calculations, the group still appears to be trading at 124x two-year forward earnings. Not to knock the performance too much, it is still up 150% from the start of 2020 versus 50% for the S&P 500. There still appears to be some air to come out of this balloon.
- T.I.N.A _ There Is No Alternative
In a world of historically low rates, pandemic induced supply issues, expanding role of monetary policy beyond price stability, and developed countries’ sole focus on “keeping the consumer spending,” investors that have long term time horizons will highly likely become frustrated with anemic returns (or even losses) generated from the fixed income asset class. While there is a considerable number of market observers pressing that equities have high valuations relative to history, investing is about making decisions today and expectations for the future. The fact is, the existing Equity Risk Premium (current cost of $1 of equity earnings vs $1 of bond income) suggests that, on a relative basis, equities remain attractive. Additionally, equities are unequivocally the single best place to be to provide a real return as inflation expectations rise. Consequently, all portfolios should be tilted to maximize exposure to this asset class subject to the over-arching asset mix strategy.
- Diversification beyond the Traditional Balanced Allocation is the Key
While there is no secret that the so called “neutral” allocation towards equities has steadily creeped upwards (50% in 1980, 60% in 2000, 70% in 2020), a truly well diversified portfolio will need exposure above and beyond just stocks and bonds to successfully navigate the coming years.
As interest rates move and bounce around from extremely low levels, we believe both equities and bonds will be subject to amplified (and sometimes extreme) valuation revisions. What this means is that price volatility is here to stay. Further, while there is debate on the pace of interest rate increases, it is widely expected that rates will rise, which will be a headwind for both stocks and bonds. This undermines the primary purpose of holding both stocks and bonds in the first place.
Portfolios may require allocations towards assets such as crypto, commodities, gold, and sustainable natural resources that provide scenario-specific inflation protection and non-correlated returns. Many portfolios are woefully underexposed to these assets.
Longer-term exposure to real assets and specific equity strategies (such as Real Estate, Global Equities, Dividend Growth, Frontier Markets and 130/30 Long Short Alternative Equity, Alternative Income among others) will not only be beneficial but necessary to minimize overall portfolio volatility.
- When it comes to Shorting, Fundamentals will Matter!
Stock fundamentals were long despised during the liquidity-infused favorable market post-March 2020. The strategy of shorting stocks will make a comeback as the market starts to move back towards fundamentals. Stocks that have no earnings, no cash flow, are highly leveraged, have questionable management and are based on living out a pipe dream (i.e., a story stock) will fall out of favor, again opening opportunities to add alpha and improve risk mitigation for portfolios. Similarly, sustainability trends will continue to create opportunities for skilled active managers. Hence our Kipling 130/30 equity portfolio structures offer an advantage.
- Increased participation in cryptocurrencies
Bitcoin has been investable for Canadians in their registered accounts for well over a year now. The newest products, ETFs, have now been around since early 2021. The SEC has now approved futures-contract based ETFs in the US (Canadian ETFs hold the physical), which has seen some inflows. There are expectations that a physical BTC ETF could be approved in 2022 and that is where we could see more institutional demand.
We welcome the opportunity to review our investment philosophy and process with you. Please reach out to us by calling 1-800-929-8296 or emailing email@example.com, and one of our Portfolio Managers will be in touch soon.