MARKET OUTLOOK:

2021 is likely to mark the third consecutive year where the S&P 500, the main benchmark for the U.S. market, returns more than 15 per cent. What are the prospects for a four-peat?

Start by recognizing just how strong the bull market, which began in March 2020, has been. Almost 21 months into this bull market, the S&P 500 has risen by more than 110 per cent, versus the average gain at this stage of a bull market since World War II of just 53 per cent. That is double historical returns and far exceeds the second-best bull market (76 per cent).  

This has led to high market valuations. The trailing price-to-earnings ratio for the S&P 500 is above 23, very high by historical comparisons. Central bank asset purchases, particularly by the U.S. Federal Reserve, have helped elevate valuations but with the Fed, in an attempt to quell inflationary pressures, about to end asset purchases and with interest rates potentially rising, valuations will have a hard time moving higher from here.

Earnings will have a hard time driving stocks higher too. S&P 500 earnings are expected to grow by 9 per cent next year but analysts are expecting this growth to be driven primarily by even higher record profit margins. This will be hard to achieve given rising wages, as workers exert pricing power over an economy short of workers, and as government deficits, which are highly correlated with corporate profit margins, contract as government spending normalizes after COVID.

Canada may be a bit of a safe haven from these headwinds. With Financials representing more than 30 per cent of the Canadian market and poised to benefit from higher interest rates through higher net interest margins, as well as lower valuations for the overall market, Canadian stocks may have the opportunity to outpace their American counterparts in 2022. 

TOP PICKS:

BANK OF NOVA SCOTIA (BNS TSX)
Last purchased on Nov 19, 2021 at $82.32
The Canadian bank that has been lagging the most both in terms of share price and earnings recovery amongst its peers and due for further catch up is Bank of Nova Scotia. Bank of Nova Scotia’s large exposure to Latin America, where the economic reopening is behind Canada and U.S., is a primary headwind facing the bank. However, as Latin America commences its own economic reopening as vaccinations expand beyond North America and Europe, Bank of Nova Scotia’s earnings and share price should benefit. Similar to its banking peers, Bank of Nova Scotia is expected to benefit from the anticipated rising interest rate environment.  

FIVE BELOW (FIVE NASD)
Last purchased on Nov 26, 2021 at $205.09
Five Below is attractive given its strong and differentiated business model, financial strength, and significant long-term growth opportunities, including the potential for 2,500-plus stores versus roughly 1,190 today in 40 states. The company has a value merchandise strategy that drives consistent demand, a new store development payback period of less than 2 years that has driven its double digit annual increase in store count, and financials that are largely consistent and predictable. The company’s new ‘FIVE Beyond’ sections are now in 30 per cent of stores, where they sell items for over $5, which is contributing to rising margins. With shares off of all-time highs, an attractive entry point now exists for long-term growth investors.

ENSIGN ENERGY SERVICES (ESI TSX)
Last purchased on Dec 10, 2021 at $1.75
Back in January 2020 before the pandemic, oil and natural gas prices were trading around $50 and $2.50, respectively. Ensign’s share price was also trading around $2.50. Today, oil and natural gas prices are considerably higher, yet Ensign is still more than 30 per cent below where it traded last January before the pandemic began. Holding the company back is a wave of capital discipline that has restrained publicly-traded E&P companies from expanding their capex budgets, as paying down debt and returning capital via dividends and share buybacks has become the new playbook. However, with steep natural declines in the Permian, where the company has most of its U.S. rigs, strengthening balance sheets across the industry, drilling budgets are gradually increasing, which should support the recovery of the company’s share price, particularly if oil prices stay above $60.

PAST PICKS: December 21, 2020

Equinox Gold (EQX TSX) 

• Then: $13.24
• Now: $8.36
• Return: -37%
• Total Return: -37%

Selectquote (SLQT NYSE) 

• Then: $22.56
• Now: $8.70
• Return: -61%
• Total Return: -61%

Aritzia (ATZ TSX) 

• Then: $25.13
• Now: $49.75
• Return: 98%
• Total Return: 98%

Total Return Average: 0%