At the close of business last Friday, global equities ended the week just shy of record levels. The yield on the benchmark US 10-year note dipped to 1.561% from 1.64% a week ago while the price of a barrel of West Texas Intermediate crude oil rose to $83.40 from $82.70. Volatility, as measured by the Cboe Volatility Index (VIX), rose to 16.9 from 16.
As we look ahead to 2022, we see a consensus in the market that is forecasting higher global short interest rates but slower economic growth. While some continue to harp on higher rates as being bad for growth stocks, we note that pre-pandemic relative performance of growth stocks was positively correlated (+55%) with interest rates.
In 2022 we are likely to see short rates rise, but due to supply chain improvements and slower growth, it’s likely we will see further yield curve flattening. This is an ideal situation for growth stocks. A slowing growth backdrop favours the secular growth names over the cyclical ones.
Despite these macro concerns, 2021 has been a strong year for your portfolio. There are many strong growth companies that your fund managers are looking at in both the US and Europe, and we continue to believe that we will experience significant upside in your portfolio over the next few years.
CANADIAN ECONOMIC NEWS
On Wednesday, the Bank of Canada ended its bond-buying program and signaled rate hikes could begin as soon as next spring, with BOC Governor Tiff Macklem saying a hike is likely sometime between April and September of next year.
Frances Donald, chief economist with Manulife, recently stated that our central bank would have to raise rates ten times before the increasing rates would have a material effect on the stock market. This reminded me of the four percent rule that Franklin Templeton investments put out decades ago.
In this article, they stated that the 10-year note under 4 percent is a very healthy environment for stocks. The US 10-year treasury currently sits at 1.561 percent. Yes, we can expect short-term rates to begin to climb in 2022, but we will remain in a historically low interest rate environment for some time to come.
US ECONOMIC NEWS
With about 55% of the constituents of the S&P 500 Index having reported for Q3 earnings, it shows that earnings growth is running at 26.5%. Sales rose about 15.5% compared with the same quarter a year ago.
The US economy shifted into a lower gear in Q3, growing at only a fraction of the pace of the first half of 2021. Gross domestic product expanded only 2% compared to the same quarter a year ago, down from a 6.7% annual rate in the prior quarter. A sharp drop in auto industry output because of a shortage of semiconductors shaved about 2.5% from the topline figure.
The spread of the Delta variant along with lingering supply chain bottlenecks helped slow the pace of growth of consumer spending significantly, to a 1.6% annual pace from 12% the quarter before.
Economists expect a moderate rebound in growth in the last quarter of the year.
Democrats aim to cement US spending plans
US President Joe Biden announced that his administration and Democratic lawmakers had agreed to a $1.75 trillion spending framework, though negotiations over the details continue. The slimmed-down package will target climate change and expand the social safety net.
Several programs have been removed from the proposal, which initially cost $3.5 trillion. A “billionaires’ tax” on unrealized capital gains was floated early in the week before being scrapped and replaced with an additional 5% income tax on those earning more than $10 million annually and a further 3% levy on those with incomes above $25 million.
Also being considered is a minimum corporate tax rate of 15% and a 1% surtax on stock buybacks. Meanwhile, progressive Democrats blocked consideration of a $1.2 trillion bipartisan infrastructure package on Thursday evening, a setback for the administration.
EUROPEAN ECONOMIC NEWS
The European Central Bank met on Thursday and did nothing but discuss inflation. However, following the meeting, Lagarde pushed back on market expectations that the ECB will begin hiking rates next year. We continue to foresee inflation in the medium term below our 2% target for the euro zone.
JAPAN, CHINA and EMERGING MARKETS ECONOMIC NEWS
The Bank of Japan remains the most dovish developed market central bank after its Thursday forecast of lower growth and zero inflation at the close of the country’s fiscal year in March.
Not so dovish is the Reserve Bank of Australia, which a day after the release of hotter-than-expected Australian consumer price data, declined to defend the 0.1% yield cap on the country’s April 2024 bond put in place as part of its yield curve control (YCC) program. The move sent the yield on that issue soaring as high as 0.75% on Friday.
The RBA meets on Tuesday, when it is expected to formally abandon YCC, which the market assumes will pull forward expectations for a rate hike from late 2023 into 2022.
Chinese property developer mulls restructuring debt
Bloomberg reports that embattled Chinese property developer Evergrande and foreign bondholders are considering talks to restructure the firm‘s debt. The two groups have exchanged nondisclosure agreements amid reports Chinese regulators are encouraging property developers to meet their offshore obligations. These investors had been concerned that their interests were not a priority for regulators.
Evergrande narrowly escaped defaulting on a dollar bond last Friday when it made its second last-minute payment this month. Ongoing turmoil in the property sector has all but paralyzed the Chinese high-yield bond market.