The week in the markets - January 14, 2022

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2021 Year in Review

Looking back, 2021 can be described as a year of continued improvement: improvement from the COVID pandemic in the form of vaccines, economic re-openings, the labour market recovery and investment performance.

From the political perspective, the start of the year saw former U.S. President Donald Trump continue with his contesting of the presidential election results which culminated in the Capitol Hill riot on January 6. In Canada, the fall brought a federal election with results that would suggest a return to status quo with the Liberals forming a minority government by winning 160 seats (up three from the 2019 election) while the Conservatives returned to the official opposition by winning 119 seats (a drop of two from the 2019 election).

The COVID virus continued to work its way through the global population with new variants emerging through the course of the year. Vaccines proved effective at providing a level of protection against the severity of COVID, allowing economies to open-up. Throughout the year, Canadian provinces were in various stages of lockdown. The increasing number of those vaccinated across the country eventually allowed for a gradual reopening. The emergence of Omicron saw some provinces return to containment measures by year-end. While the newly identified variant proved to be many times more transmissible, it seems to be milder than the Delta and Alpha variants before it, presenting hope that we may be nearing the end of the pandemic.

Economic conditions around the world, including Canada and the U.S., continued to improve supported by the monetary and fiscal stimulus measures by governments and central banks. In Canada, the unemployment rate fell from its pandemic high of 13.7% to 5.9% by the end of 2021. The Canadian labour market has improved markedly over the past year as all the jobs lost during the pandemic lockdowns have been recovered, while the unemployment rate at year-end sits a mere 0.3% above the pre-pandemic level of January 2020.

The economic reopening has not been without consequence however, as inflation in many areas around the world has accelerated to levels not seen in decades. In Canada, the Consumer Price Index (CPI), the measure of inflation, surged by 4.7% year-over-year (yoy) in November, the highest gain since 2003. In the U.S., CPI gained 6.8% yoy in November, the strongest consumer price inflation since June 1982.

Bond investors were challenged as yields headed higher, responding to inflation. The benchmark US 10-year Treasury gained 60 basis points (bps) over the year to close at 1.51% as bond markets priced in higher inflation and forthcoming monetary tightening by the U.S. Federal Reserve. In Canada, the 10-year Government of Canada Bond yield gained 74 bps over the year to end 2021 at 1.42%.

Equity investors were rewarded with another strong year of returns as corporate profitability not only recovered to pre-pandemic levels but exceeded them. The S&P/TSX Composite Index gained 21.7% on a price return basis and 25.1% when including dividends. The S&P 500 Index, the U.S. benchmark for stocks gained 26.9%, and 28.7% when including dividends in U.S. dollar terms (26.4% and 28.2% in Canadian dollars respectively). The MSCI EAFE Index, a benchmark for International stocks, gained 8.3% on a price return basis and 11.3% when including dividends in Canadian dollar terms.

Overall, 2021 was a year of progress with momentum that looks to continue into 2022.

The Week In The Markets

Inflation, momentum and the laws of physics

Inflation and the potential for rate increases by central banks left equity investors searching for direction this week.  Technology companies were particularly sensitive to the rate-hike speculation.  Buyers stepped in to take advantage of the dip early but were outnumbered by sellers over the course of the week. The NASDAQ Index rose near 5% from its intra-day low on Monday only to give back much of the gains through Friday.  Gold, copper and oil each gained on the week, while the US 10-year Treasury yield and the 10-year Government of Canada bond yield were little moved. Investors’ area of focus, however, returned to inflation and the pending policy response by the US Federal Reserve.

Gains across commodities helped edge the TSX higher during the week. Oil prices crossed above US$80/bbl, while gold climbed. Typically viewed as a hedge against inflation, gold has suffered from a somewhat lacklustre performance since its mid-2020 high of US$2,063/oz. With renewed inflation expectations, gold may yet reassert its relationship to inflation.

The US Consumer Price Index (CPI) gained 7% on a year-over-year basis through December, reaching a high not seen since 1982. Core CPI, which excludes food and energy, climbed to 5.5%. With inflation clearly in the crosshairs of the Fed, expectations for rate increases have shifted to a faster pace.

Currently, expectations are for the Fed to start raising rates at its March meeting, by 0.25 of a percentage point, with an additional three rate hikes priced in for the remainder of 2022. Bond yields that saw significant moves last week were little moved this week. Investors are likely taking a breather while waiting for the Fed’s next signal. Inflation, meanwhile, continues to advance.

Next week will see the release of Canada’s Consumer Price Index for December. November’s inflation rate came in at 4.7% year-over-year. While Canadian CPI hasn’t reached the same level as in the United States, the direction has been the same. Market expectations are for the Bank of Canada to respond through the year with upwards of five rate increases, to an implied overnight rate of 1.5% by year-end. 

However, as COVID-19 case numbers climb with the omicron variant, and with the resulting lockdowns across several provinces, including Ontario and Quebec, the BoC is unlikely to change policy with January’s announcement. A March hike is on the table.

The challenge with inflation is that it is like a freight train: slow to start, but as momentum builds, hard to stop. The laws of physics tell us that momentum is a vector quantity, that is, it has both magnitude and direction. Currently, both magnitude (near a 40-year high) and direction (increasing over the past year) are keeping inflation’s momentum positive.

To slow inflation down will require an effort of similar magnitude and opposing direction, in other words: rate increases. Any response by the Fed, or Bank of Canada for that matter, is unlikely to have an impact on inflation for 12-18 months. In this regard, while it is likely to moderate, higher inflation may remain with us through the bulk of 2022.

This weeks market closing value - Week ending January 14, 2022

EQUITY INDICES Level Change 1-week YTD 1-year 5-year
S&P/TSX 21,357.56 273.11 1.30% 0.63% 18.93% 6.63%
S&P 500 4,662.85 -14.18 -1.02% -2.83% 22.00% 14.43%
DJIA 35,911.81 -319.85 -1.60% -1.84% 15.07% 11.57%
FTSE 100 7,542.95 57.67 0.66% 2.46% 10.00% 1.99%
CAC 40 7,143.00 -76.48 -1.32% -0.47% 17.23% 8.29%
DAX 15,883.24 -64.50 -0.66% -0.34% 5.86% 6.99%
Nikkei 28,124.28 -354.28 -0.81% -2.21% -11.55% 6.95%
Hang Seng 24,383.32 889.94 3.21% 3.63% -15.40% 0.27%
CURRENCY RETURNS CAD Change 1-week YTD 1-year 5-year
US$ 1.2552 -0.0091 -0.72% -0.67% -0.70% -0.87%
Euro 1.4325 -0.0037 -0.26% -0.33% -6.77% 0.52%
Yen 0.0110 0.0000 0.44% 0.11% -9.75% -0.82%
3-month 0.26 0.06 Oil $83.82 $4.92
5-year 1.57 0.06 Gold $1,817.94 $21.39
10-year 1.77 0.05 Natural Gas $4.26 $0.35