Making sense of the markets this week: December 12
How investors are looking at Omicron, shrinking pipeline dividends, the news from BlackRock and more.
How investors are looking at Omicron, shrinking pipeline dividends, the news from BlackRock and more.
Each week, Cut the Crap Investing founder Dale Roberts shares financial headlines and offers context for Canadian investors.
You may remember that last week I wrote:
Omicron continues to steal the headlines—and the attention of investors. When this new and concerning variant first came to our attention, stock markets sold off. As has long been suggested in this column, stock markets do not like uncertainty. And Omicron was a mystery. We fear the unknown.
It’s still early days, in what might be a new Omi-inspired stage of the pandemic. The markets, and many medical experts around the globe, are becoming more accepting of the new phase. Fear is dissipating somewhat, and stock markets roared back to “risk-on” mode.
Here’s how the U.S. stock market (S&P 500) responded:
Markets were up again on Wednesday, December 8. The next day, they were taking a bit of a breather. Canadian markets followed the U.S. lead.
The optimism is based on limited and early analysis of Omicron, but it was enough to move the markets, according to this CNBC post:
“Time will tell whether investors are getting ahead of themselves but a couple of days without a negative omicron headline has the dip buyers flooding back in,” said Craig Erlam, senior market analyst at OANDA.
“On Friday investors rotated out of tech stocks on those Covid-related fears, and into names linked to the recovering economy. Many market strategists and analysts have called this an overreaction but Erlam urged cautious optimism.”
And, once again, it was the retail investor that bought the proverbial dip. This is from Forbes:
Despite the market having its worst day of the year on Friday, November 26—with the Dow dropping 950 points, investors bought the dip en masse last week, according to recent data from Bank of America. The firm said that total stock inflows from clients totaled $6.7 billion last week—the highest intake since 2017.”
The price of oil took a major hit, down 15%, when Omicron first offered a glimpse of its unique spike proteins. Oil stocks sold off as well. I embraced that risk and added to Ninepoint Energy (NNRG) last Friday at $27.80. The Energy ETF is trading at $30.88 as I write this. A nice short-term jump. That said, anything can happen, and I doubt that Omicron is done on the fear-factor front.
While there is no definitive answer for the week ending on December 12th, the early reports seem to suggest that Omicron stands a very good chance of becoming the dominant variant at large across the globe.
We don’t know how Omicron will steer the direction of the pandemic. My framing from last week still stands:
“On the other hand, the Omicron variant may pose no threat, or it might be the status quo on the pandemic front. Or, this prolific variant (it has more mutations than other previous variants) might pose a real threat. If it can evade vaccines, we might be somewhat starting over. At the other end of the spike protein spectrum, Omicron may be the best thing that has happened during this pandemic.”
If Omicron becomes the dominant variant and is far less dangerous, we might potentially get to the other side of the pandemic in accelerated fashion and with less harm.
It will come down to the danger level of this new variant.
BlackRock (BLK), the world’s largest asset manager, offers three investment lessons from 2021. This paragraph sets the table for the report:
“As 2021 draws to a close, we draw three lessons. First, you need a compass to navigate the unique backdrop of a noisy restart of economic activity. Ours was the New nominal: The policy and market response to inflation would be historically muted. Second, realize that the journey for the world to reach net-zero emissions by 2050 is starting now. Third, have courage of conviction.”
In this Making Sense of the Markets column, I looked at the mid-year review from our friends at BlackRock. Back in July, BlackRock offered:
“A restart is not a traditional business cycle recovery—you can only turn the lights back on once, so to speak. Fiscal stimulus and easy monetary policy have provided a bridge through the pandemic. We have estimated the U.S. has seen more than four times the stimulus compared with the GFC [Great Financial Crisis] for less than one-quarter the shock.”
“We are taking advantage of the pullback in U.S. inflation breakevens to return to an overweight on Treasury Inflation-Protected Securities (TIPS). We find TIPS particularly attractive relative to inflation bets in the euro area where the outlook for inflation remains sluggish. We also like other inflation-linked exposures, such as commodities and real assets. We prefer TIPS to nominal U.S. Treasuries.”
Inflation-linked exposure has been a common theme in this column. We covered those Canadian options for TIPS in this post. Personally, I’m more inclined to use commodities and real assets as they offer more torque, in the fight against inflation. But many investors will certainly go at inflation from all sides, with commodities, other real assets, and an inflation-adjusted bond component.
BlackRock more recently reports:
“Our anchor to interpret this macro environment has been that normal business cycle logic does not apply. The COVID19 shock was more akin to a natural disaster, followed by a powerful restart of economic activity. This restart is nothing like the long, grinding recovery following the 2008-2009 financial crisis. It’s more like the world turned the lights back on. Economic activity surged, corporate profits rebounded at an astonishing pace in the restart, and developed market (DM) equities ripped.”
From that report, here’s a chart that shows the returns of select assets:
Within that report, you will see BlackRock’s overweight and underweight positions for 2022.
On the big question of inflation they feel rates will be systematically higher in the next few years, compared to pre-COVID. We might have to get used to inflation in the 3% to 4% range.
This week there were many warnings on the food inflation front. There is an obvious advantage to hedging everyday spending with some inflation protection in your TFSA or taxable account.
And from another asset manager giant, Vanguard offered a report with estimates for returns for assets over the next decade. Here’s an excerpt:
|Equities||Return projection||Median volatility|
|U.S. real estate investment trusts||1.9%–3.9%||19.1%|
|Global equities ex-U.S. (unhedged)||5.2%–7.2%||18.4%|
|Global ex-U.S. developed markets equities (unhedged)||5.3%–7.3%||16.4%|
|Emerging markets equities (unhedged)||4.2%–6.2%||26.8%|
The big eye-opener in those projections is the negative return projection for U.S. growth stocks and the much greater returns (potentially) available in non-U.S. global stock markets.
The above are projections, and past performance is certainly no guarantee of future returns.
This week the Canadian pipeline company Enbridge (ENB) delivered a very modest dividend increase of just 3%. Enbridge had previously provided guidance that dividend increases would be in the 7% to 10% range.
That said, earnings and free cash flow projections from Enbridge are quite positive.
Enbridge reaffirmed its 2021 full-year guidance with EBITDA (earnings before interest, taxes, depreciation and amortization) of $13.9-billion to $14.3-billion, and distributable cash flow per share of $4.70 to $5.
For 2022, the company expects adjusted EBITDA of $15.0-billion to $15.6-billion, and distributable cash-flow per share of $5.20 to $5.50.
TC Energy (TRP) has also recently suggested that its dividend increases will moderate to the 3% to 5% annual dividend growth range.
Should investors be concerned?
I checked in with Mike Heroux who owns and operates the investment service, Dividend Stocks Rock. Here’s what he says:
“Enbridge has spoiled investors with several double-digit dividend increases in the past. The party stopped last year with a 3% increase and another 3% increase this year. TC Energy similarly treated investors with several high-single digits increases in the past. Investors were up for a cold shower when management announced the dividend would grow between 3% and 5% going forward.”
Mike offers that management is operating in a responsible fashion. As investors, we want to check that the dividends are covered by free cash flow. Heroux again offers insights:
“Both ENB and TRP show a stronger distributable cash-flow-per-share growth rate than their expected dividend growth rate. It’s not necessarily a bad thing.”
Keep in mind that Enbridge and TC Energy are still two of the most generous dividend payers in the Canadian market. Enbridge pays a 7% annual dividend, while TC Energy sports a 5.9% yield. Those are massive payments, and many would consider those investments a bond proxy. While we should never fool ourselves into thinking that stocks can be bonds, shading to some generous but defensive stock income is worth consideration when bonds deliver a negative real (inflation adjusted) yield.
Reliable and generous income can be quite advantageous for the retiree. While those in the accumulation stage might concentrate on total returns—making the most money over time, regardless of the portfolio yield. Of course, in Canada, we quite often see that investors can build incredible wealth by way of the Canadian dividend payers.
As always, consider your risk tolerance level and tax efficiency. Geographic diversification should also be on the table.
I own Enbridge and TC Energy. I like them for their generous income and their defensive posture. In ironic fashion, I will reverse the flow and connect those pipes to my oil and gas stocks. I also invest in bitcoin, and my allocation has dropped below 5%. My bitcoin fund will be topped up by way of those pipeline dividends and the big bank dividends that are set to arrive in January.
The S&P 500 is up over 25% year-to-date. Barring a very major correction the market could deliver another year of double-digit returns. That would make it a hat trick (three years in a row) for the U.S. stock market.
U.S. stocks offered a 31% return in 2019, in 2020 they kicked off the decade with an 18% return. DataTrek notes that it would mark only the tenth time the index has bagged a hat trick over the past 90 years. From DataTrek (via email) …
“These 3-peat clusters span all the way back to the early 1940s-1950s and mid-1960s to the late 1990s and mid-2000s. The average total return for the third straight year of double-digit gains is 22.8%.”
The average annual return for U.S. stocks following a double digit hat trick is 8.4%. After the nine hat tricks, the following year was positive five times, and negative four times.
Here’s the post-hat trick scorecard courtesy of that DataTrek email:
The last positive (but not double-digit) year after a three-peat of +10 pct returns was in 2015 (+1.4 pct).
Of course, we can flip a coin as to the direction for markets in 2022. But what is interesting is that there are so many double-digit four-peats and one double-digit five-peat. Stock market momentum and sentiment can be a powerful force. Just because U.S. stocks are expensive, and 10-year return projections are not favourable, that does not mean they can’t continue to astonish to the upside next year.
Those who hold balanced portfolios might be prepared to sell high-flying U.S. stocks and rebalance to risk-off assets and to stocks and stock funds that offer greater value. There may be very generous profits to be harvested and redistributed.
At times, making sense of the markets means acknowledging that the markets and market returns don’t have to make sense.
Be prepared for anything, even a pleasant surprise.
And for a smile …
Dale Roberts is a proponent of low-fee investing and he blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge for market updates and commentary, every morning.
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