MARKET OUTLOOK:

What’s the most important thing to consider when investing? The answer is, “don’t fight the Fed.” When the U.S. Federal Reserve cuts interest rates, stock markets tend to rise. When it raises interest rates, stock markets tend to fall. If tapering and rate increases are on the menu in 2022, stock markets may be tested negatively.

The last time we saw rising interest rates and overvalued stocks was in the fall of 2018. During a 3-month time-span from October 1 to December 23, technology stocks and small-cap names took the brunt of the punishment. The Russell 2000 Small-Cap Index plummeted 23 per cent, the NASDAQ technology index fell 21 per cent, the S&P 500 Index dropped 17 per cent and the Emerging Markets Index lost 8 per cent of its value.

Looking ahead to 2022, and based stock valuations via price/earnings multiples, the Nasdaq trades at 34x earnings, followed by the Russell 2000 at 31x, the S&P 500 at 22x and the Emerging Markets Index at 12x. The first two indexes appear quite expensive, while the S&P 500 seems overvalued and the Emerging Markets Index looks cheap.

For investors, I would caution against owning a portfolio of only tech names and/or small-caps as they appear the most exposed to downside risk. If 2022 turns out to be a year of P/E multiple contraction because of higher interest rates combined with only adequate earnings, results could be similar to 2018’s final quarter. Portfolios should be diversified and investors should think about risk-adjusted returns, not nominal returns.

TOP PICKS:

TD Bank (TD TSX)
Bought at $95.23 
A cross-border Canadian bank with revenues in both Canada and the United States. A rise in interest rates should help TD’s net interest margin (NIM) growth and profitability, currently at 1.5 per cent (the lowest of the Canadian banks). The latest 13 per cent dividend increase to a current 3.74 per cent dividend yield gives investors bond-like income with the potential for capital appreciation.

Paychex (PAYX NYSE)
Bought at $132.23
Provides comprehensive payroll and integrated human resource and employee benefits outsourcing solutions for small and medium-sized businesses in the United States. The most recent quarterly results beat expectations and the company also raised its full-year forecast. The 2 per cent dividend yield is well above the S&P 500 Index average of 1.3 per cent.

Intertek Group PLC (ITRK LON)
Offers product inspection services. The company inspects products for safety to governments, exporters and importers as well as certifies that import duties are declared and paid. The company has been a victim of a slowdown in government spending during COVID-19. If economies recover to any level of normalcy, Intertek should return to higher revenues, profits and dividend increases.

PAST PICKS: August 25, 2020

Atrion (ATRI NASD) 

• Then: $672.00
• Now: $659.47
• Return: -2%
• Total Return: 0%

Analog Devices (ADI NASD) 

• Then: $119.90
• Now: $172.66
• Return: 44%
• Total Return: 47%

Steris PLC (STE NYSE) 

• Then: $154.59
• Now: $241.07
• Return: 56%
• Total Return: 58%

Total Return Average: 35%