After the U.S, Canadian and global equity markets achieved a record-breaking year in 2021, markets have become jittery over talks of inflation and interest rate hikes.

U.S. inflation has climbed to 7%, its highest level in 40 years. The Fed has stated it expects inflation to begin cooling by the second half of 2022. In the meantime, it has projected at least three interest rates increases this year.  In addition, the Fed announced it will double the pace at which it winds down its pandemic stimulus, from US$15 billion to US$30 billion a month.

In Canada, inflation headed north as well, hitting 4.7%, its highest level since 2003. The Bank of Canada noted it could be ready to start raising interest rates as early as March 2022. It also announced it was ending its pandemic stimulus.

It is important to remember, raising interest rates is needed to control inflation. The economy is running at full capacity, including a labour market that is back to pre-pandemic levels. By removing stimulus, the economy will slow and return to a more normal pace.

What can we expect next?

The start of the new year has been met with broad weakness across stock indices as investors digested receding monetary and fiscal liquidity, persistent effects from COVID-19, and a rise—but potential eventual easing—in inflationary pressures. The areas undergoing the most intense selling pressure are the speculative areas of the market, which all gained incredible steam in 2020 and the early part of 2021.  Even with new restrictions induced by the omicron variant, leading economic indicators still suggest positive momentum in advanced economies, likely due to the belief that the current Covid wave will be short-lived.  

On the inflation side, the contribution of energy should fade, while investments in supply chain capacity should begin unclogging global bottlenecks in the second half of 2022. But don’t expect a whiplash to below 2% inflation: tight conditions in housing and labour markets should maintain inflation above target in the US and Canada in 2022.

In Canada, growth is especially sensitive to a slowdown in housing: residential investment currently makes up 9.2% of Canadian GDP, compared to 4.3% in the US and to a 2010-2020 average of 7.2%. Housing starts were still very solid in November, but anything more than a gentle decline in residential investment would threaten 2022 growth.

The expectation for 2022 is a global growth rate of 4% and moderating inflation in the major advanced economies, leading to a gradual rise in central bank policy rates.  There will be a flight to quality away from speculation, a compression of earnings, and best case scenario a more tempered single digit rate of return.  This of course does not factor two potential risks, namely: (1) the entrenchment of persistent inflation due to continued supply shortages and shifting long-term inflation expectations, and (2) a slowdown in growth caused by policy tightening and/or virus uncertainty.

Regardless of what is happening in the markets, it’s important to take a disciplined approach to investing.  Maintaining a diversified mix of asset classes in your portfolio to maximize potential returns and minimize risk has served us well and will continue to be the strategy moving forward. 

As always, if you have any concerns or would like to discuss your investment portfolio, or your overall financial planning needs, please don’t hesitate to contact me.

Have a great week,

Tracey

Sources: Original article by Leo Belmonte, CEO, Security Financial Services, Investment Executive article posted 01-26-22 by IE staff, with files from Canada Press

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