How this all ended up playing out for markets in November was mostly negative.  In the U.S., the large cap tech stocks once again held ground and even attracted some new buying as they have almost become the ‘de facto safe haven’ trade.  Investors seem to believe that people will always need a new iPhone and use it to buy things from Amazon, all while pushing their data and programs into the ‘cloud’, dominated by Microsoft, Google and Amazon.  Outside of those heavyweights, almost everything else was for sale.  Small cap stocks were particularly hard hit, both on year-end tax loss selling and earnings worries from slower growth and higher interest rates.  The Russell2000 Index lost 4.3% last month while the large stock oriented S&P500 Index shed only 0.8% and the tech heavy Nasdaq Index was actually very slightly positive on the month.  Outside of the U.S. the results were worse; while strength in gold stocks kept the loss in the Canadian TSX Index to only 1.8%, Japanese stocks fell 3.7%, Hong Kong dropped 7.5% and the European Stoxx50 Index dropped 4.4% as Covid cases rose sharply and some lockdowns were re-instituted in Austria and Germany.

Even though stock markets have surged to record highs, the public has yet to be convinced that times are really that good.  As shown below in the chart of U.S. Consumer Sentiment, there was some recovery from the record drop in confidence that occurred at the beginning of the pandemic.   But that sentiment has faded this year as consumers feel less confident that the stimulus measures from 2020 will remain in place, that global supply chain issues will get resolved and that the resultant inflationary pressures will subside anytime soon.  Sentiment has fallen to the lowest level of the past nine years.  That can’t be good for spending in the upcoming Christmas season or positive for all the re-opening and travel plans anticipated for 2022.Consumer Sentiment Index

This loss of confidence and increased apprehension about risk is not limited to the U.S. consumer.  The European Central Bank (ECB) has warned in its twice-yearly financial stability review that “increased “exuberance in housing markets, junk bonds and crypto assets have created vulnerabilities that will be exposed if higher than expected inflation leads to a sharp rise in interest rates.  Concerns particularly relate to pockets of exuberance in credit, asset and housing markets as well as higher debt levels in the corporate and public sectors.  Rising inflation and falling real interest rates have prompted investors to take greater risks in their search for yield, which has left parts of the property, debt and crypto asset markets “increasingly susceptible to corrections.  A correction in markets could be triggered by a weaker than expected economic recovery, spillovers from adverse developments in emerging market economies, a re-intensification of stress in the non-financial corporate sector or abrupt adjustments in market expectations regarding the prospective path of monetary policy normalisation,” it said.  Eurozone inflation rose to a 13-year high of 4.1% in October, well above the ECB’s 2% target. The central bank, however, has predicted inflation will fall back below its target in the next few years and said it did not expect to raise rates next year.  Seemingly on the U.S. Fed’s ‘transitory inflation theme, it noted there was “a risk that recent strains in global supply chains and the spike in energy prices could have longer-lasting effects on inflation than expected”.

As if that wasn’t enough, former ‘bond king’ Bill Gross chimed in with some even sharper rhetoric.  “Investors are living in a dreamland brought on by global central banks’ decision to continue pumping up the world economy even as it has rebounded sharply from the pandemic.  Historically low interest rates and mammoth bond-buying programmes, which are only now being cautiously scaled back, have nurtured a widespread bout of financial euphoria in everything from stocks to digital assets such as “non-fungible tokens”, the founder of bond investment group Pimco told the Financial Times in an interview.  “It’s dangerous,” Gross warned of accommodative central bank policy.  It’s all dreamland that’s been supported by interest rates that aren’t anywhere close to where they should be.” 

One more opinion in this vein, we had to throw in recent comments from Liberty Media Chairman John Malone, who said the market’s fixation on growth and soaring equity valuations remind him of the dot-com bubble in the late 1990s.  “There’s no question that the equity markets right now are so interested in growth above all other criteria and this is, like, the bubble in the late ’90s … through 2000.  This is a land rush right now. Profitability to be determined later.”

Summing up all these opinions and data;  Stocks continue to be supported by record low interest rates, fiscal spending, surging profits and a global economy recovering from the pandemic.  However, the massive liquidity and a flood of new retail investors has fueled a level of speculation unlike anything we have seen since the late 1990s and should raise warning flags for all investors.  Valuations are at record levels for those companies with actual earnings and are even higher for many ‘growth’ companies that are pre-earnings; e-car makers Rivian and Lucid are making Tesla look like a deep value, blue chip stock!  When speculative fever lessens, these stocks can have significant downside;  just look at 50%+ drops in names like Zoom, Peleton, Beyond Meat or the entire Canadian pot sector after the excitement wears off and earnings need to be delivered.  Our strategy for 2022 is to stay with stocks

Momentum is strong going into year end but the setup seems a bit reminiscent of 2017 when a year long, uninterrupted rise in prices gave way to two sharp corrections in 2018 as interest rates began to rise.   However we are still early in the new economic cycle and believe that the ‘supply chain’ issues that are hurting some earnings in the short term may actually end up extending the economic cycle, since this is not a demand issue.  Also, given the massive rise in global debt, we don’t see an ability for central banks to do anything more than ‘normalize’ the interest rate structure despite short-term inflationary pressures.  Given that the alternatives to stocks remain unattractive, our strategy for 2022 is to stick with stocks but continue to rotate to those groups that have valuation support, high dividend yields and leverage to a slower growth economy.   Industrials, autos, financials, telecom and energy infrastructure all fit that criteria.  We also believe gold should do better in this environment;  massively negative real interest rates, rising inflation and gold stock valuations are multi-decade lows provide a good risk-reward setup for the group, despite continued money flows into the crypto world as an alternative.

1 2