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BofA Securities’ widely-followed U.S. quantitative strategist Savita Subramanian has updated her S&P 500 forecast for 2022 and for investors the news is … not great. The 4600 target is less than 2 per cent higher than current levels.

The main limiting factor for equity gains is not the economy – BofA is bullish on U.S. growth - it’s the Federal Reserve. Ms. Subramanian estimates that the central bank’s post-financial crisis monetary expansion is responsible for more than 50 per cent of S&P 500 gains since 2010, and the expected tapering of monetary support next year will result in market weakness.

The dominance of growth stocks in the benchmark has made U.S. stocks highly sensitive to changes in interest rates, and this will require some explaining.

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The most commonly accepted definition of an equity’s correct price is the use of discounted cash flow analysis to calculate the present value of future cash flows or, more simply, the current value of future earnings.

Investors do not need to do this math themselves, but they do need to know that high growth stocks respond extremely negatively to increases in interest rates. And the S&P 500, with the five biggest growth-oriented technology stocks making up between 20 and 25 per cent of its market capitalization, will take a hit if the Federal Reserve’s monetary tightening results in higher rates.

Ms. Subramanian estimates that the S&P 500 will fall four per cent for each one-tenth of a percentage point increase in the 10-year Treasury bond yield. This will be offset by other positive factors like earnings growth, but it does highlight the danger of higher bond yields to equity returns.

The strategist warned B of A clients about upcoming volatility in blunt terms rarely seen in research reports. “This [rally] may not end now. But when it ends, it could end badly,” she wrote. “If taper means no upside to the S&P 500, tightening [raising interest rates] would be worse”.

Ms. Subramanian recommends investors add portfolio positions in dividend growth stocks in sectors like energy, financials and materials that have historically outperformed during periods of inflation.

-- Scott Barlow, Globe and Mail market strategist

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

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The Rundown

Liberal campaign promise for new bank tax tempers investor expectations

A Liberal Party campaign pledge to raise taxes on large banks and insurers is weighing on the share prices of large financial institutions and creating uncertainty for investors expecting a windfall from bumper profits the sector has earned so far this year. Shareholders have been waiting for the banking regulator to lift temporary restrictions on dividend increases and stock buybacks. But if the Liberals are re-elected, their promised tax hikes could eat into the excess cash banks have to dole out to investors. David Milstead and James Bradshaw report.

Why the investment industry refuses to answer a basic question its customers keep asking

The question investors never stop asking our personal finance columnist Rob Carrick: are returns for mutual funds and exchange-traded funds published on a before-fee or after-fee basis? Silly investors, right? How could they not know that the standard is for fund returns to be published on a net basis, which means after fees? Well, Rob is taking a different view.

Three top infrastructure stock picks from dividend portfolio manager Ryan Bushell

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While all stocks have risk, portfolio manager Ryan Bushell’s focus is on growing companies with hard assets that produce steady cash flow and dividends. That means he’s largely staying clear of the high-flying technology sector and keeping a steady income stream coming in. His clients are seeing benefits, with his portfolio returning 39.6 per cent over the past year. Brenda Bouw found out about three of his top picks related to infrastructure.

Banks halt sales of third-party mutual funds to prepare for rule change

Several of Canada’s largest banks have halted sales of third-party investment products from their financial planning arms as new regulatory rules will soon require advisers to have deeper knowledge of the funds they recommend to clients. Royal Bank of Canada, Toronto-Dominion Bank and Canadian Imperial Bank of Commerce have all notified clients in their financial planning businesses that advisers will no longer be selling third-party funds for any investment portfolios. Clare O’Hara reports.

Investors grow wary as stocks hit new highs

Investors are girding their portfolios for potential stock market volatility, even as equities hover near fresh highs after logging seven straight months of gains. In derivatives markets, the gap in price between the front month Cboe Volatility Index futures contract and the VIX index itself is higher than it has been about 85 per cent of the time over the past five years. This suggests some investors expect the calm in stocks to give way to more pronounced price swings in the coming weeks and months. Meanwhile, the Japanese yen and Swiss franc – viewed as havens during uncertain times – have outperformed most Group of 10 currencies this quarter. And the positioning for stormier times ahead doesn’t end there. Saqib Iqbal Ahmed of Reuters reports.

Hedge funds in historic double-down on higher U.S. yields

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Not only are hedge funds ramping up their bets on a higher 10-year U.S. Treasury yield, they are doing so on a historic scale. Jamie McGeever of Reuters reports.

Others (for subscribers)

Number Cruncher: Eight U.S. defensive dividend stocks for a frothy market

Wednesday’s analyst upgrades and downgrades

Tuesday’s analyst upgrades and downgrades

Tuesday’s Insider Report: Several yield plays that management executives are buying

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Wednesday’s Insider Report: CEO accumulates units of this retail REIT

Bombardier to rejoin Canada’s biggest stock index

Globe Advisor

The Financial Times: Why Europe’s markets regulators are worried – about everything

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Ask Globe Investor

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Question: Many foresee another “wave” in this pandemic with the Delta virus and the fear of even more serious variants developing. What is that going to do this time to regular blue-chip stocks? – Jennifer W.

Answer: Stocks (blue-chip and others) have done very well throughout the pandemic, after the market plunged in March 2020 when the seriousness of the coronavirus became apparent. It turned out to be the shortest bear market in history as all North American indexes rallied back to record highs.

There are four major reasons why this happened.

First, central banks slashed interest rates to near zero and reintroduced quantitative easing programs to stimulate the economy.

Second, massive government spending programs provided support for laid-off employees, small businesses, renters, and others affected by the pandemic.

Third, stock markets always look to the future, not the past. Markets rose in anticipation of a recovery that would produce higher corporate profits, which has happened.

Finally, low interest rates have reduced real yields on bonds (after accounting for inflation and taxes) to negative territory, leaving stocks as the only profitable option.

As you note, we are now in the fourth wave of the pandemic. How bad will it be and what will be the impact on stocks? Even if it’s as bad as previous waves, which is doubtful because more people are now vaccinated, I doubt we will see the kind of reaction as we did in March 2020. The safety mechanisms I mentioned are still in place and the recovery mentality continues to drive prices higher. Even record new infections in places like Florida and Texas aren’t slowing down the markets.

However, given the strong run the markets have enjoyed, we are likely to experience a slowdown going forward. Prices are high and the components aren’t in place to sustain the recent momentum we’ve enjoyed.

The bottom line is the growth pattern of your blue-chip stocks is likely to slow, no matter what happens. That said, I’d continue to hold them for the long term.

--Gordon Pape

What’s up in the days ahead

Rob Carrick will tell us why the move by three big banks to ban sales of third-party mutual funds by their financial planners is bad for customers.

Click here to see the Globe Investor earnings and economic news calendar.

More Globe Investor coverage

For more Globe Investor stories, follow us on Twitter @globeinvestor

You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.

Compiled by Globe Investor Staff

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