I consider myself an optimist, but that doesn’t mean throwing reality out the window. And I don’t see much reality in many of the predictions of what can be expected with capital markets in 2022. Indeed, shifting people’s attention to bullish outcomes is what I call “Bullshift” and it’s rampant in the financial services industry. While it has mostly served investors well over the years, it has morphed into a mindset where no one thinks a significant drawdown is possible, owing to central bank interventions these past 21 months.
A recent article in The Globe and Mail by Brian Belski, the chief investment strategist at BMO Capital Markets, said the bull market looks as if it will be alive and well in 2022. I find that dubious. The phenomenon Mr. Belski exhibits is known as “optimism bias” and it doesn’t always serve investors well. In fact, on average markets go down nearly every third year. Despite this, the industry predictably whistles past the graveyard and fails to properly alert investors of looming risks. Nowadays, we should all be very concerned about a coming correction that I think will be huge. Let’s look at the U.S. market:
- The cyclically adjusted price-to-earnings (CAPE) ratio for the S&P 500 is now around 40 – the second highest ever.
- The S&P 500 has finished up in 12 of the past 13 years and 17 of the past 19.
- From 2019 to 2021, the U.S. market has more than doubled – the best three-year run since 1997-99.
- The biggest drawdown (peak-to-trough decline) in the S&P 500 last year was a paltry minus 5.2 per cent.
- Today, inflation in the United States is more than 6 per cent – the highest in 30 years.
- Government debt levels throughout the Western world have never been higher in peacetime than they are now.
In essence, investors act like there is no such thing as reversion to the mean, while central bankers have somehow devised a sort of capital market alchemy where bear markets have been eradicated – like smallpox. They are also guilty of “recency bias.” Because the drawdown of early 2020 was met with a swift and successful response, advisers and their clients alike think of themselves as being bulletproof and immune to market forces. People are frighteningly overconfident.
In his article, Mr. Belski wrote: “We continue to believe U.S. stocks are in the early stages of transitioning toward an earnings driven, more fundamentally defined performance trajectory, especially relative to the heavily laden, momentum trading strategies that have defined much of the performance in the past few years.” I could not disagree more. I believe we are in the late stages of a long-in-the-tooth market that is rising on both accumulated momentum and misplaced confidence.
Most astonishingly, Mr. Belski concludes with: “Our 2022 outlook assumes a return to normalcy and a transition to a more earnings-driven environment, which is likely to see greater bouts of volatility and the increasing importance of stock selection.” Individuals who claim expertise in stock selection are loath to admit the environment is ever negative.
Even more disconcerting is Mr. Belski’s phrase “return to normalcy.” Central banker alchemists, the heroes of this fairy tale, are heroes because they kept the punch bowl out longer than ever before with better results than ever before. The last time they hinted at even modest rate hikes (25 basis points in the fourth quarter of 2018), both the S&P/TSX and S&P 500 wound up dropping about 20 per cent. Now, Mr. Belski says he believes bankers will raise rates three times in 2022 (the consensus interpretation of “normalization”), but that markets will nonetheless yawn and continue their upward trajectory.
No one knows what will cause markets to drop, when this will happen, how far they will go or how long the drop will last. All I know are two things. First, there is no evidence markets can keep climbing indefinitely. Second, despite this, the financial services industry is unwilling or unprepared to alert its clients of looming risks. This unwillingness to provide fulsome context is characteristic of the industry. All signs point to a major downturn soon – maybe one worse than anything we have ever experienced. But you’d never know it by what economists and pundits are saying. And that’s why it’s dangerous.
John De Goey is an adviser and portfolio manager at Wellington-Altus Private Wealth.
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