Lexicon Financial Group Weekly Update

Monday, January 10, 2022


Belated “happy New Year” to everyone. Here’s hoping that 2022 is the year we finally crack COVID’s code. Also may you and your family have a wonderful, safe and prosperous 2022! Please note that we will be sending you communications this month regarding tax-free savings accounts (TFSA) and a new trusted contact policy.

 

Looking Back

Since this is the first weekly update of 2022, it’s only fair that we pause for a moment and reflect on investment markets in 2021. In general, equity market returns around the world were strong, but fixed income returns languished.

Equity investors saw strong double-digit returns from most parts of the world. In Canada, the S&P TSX index posted a 24.4% annual rate of return. Returns in the US were even higher – the S&P500 soared 26.9% and the NASDAQ returned 21.4%. Not to be outdone, European equity markets held their own, the EURO STOXX 50 index returning an impressive 21.0%. (1)

Interestingly, every sector of the S&P500 was up over double digits in 2021, led by energy (47.7%), real estate (42.5%) and financials (32.6%). Canadian markets showed more volatility - the health care sector actually lost 23.6%, and the energy sector climbed 80.0%. (2)

On the fixed income side, it was a completely different story. Canadian bonds (as measured by iShares Core Canadian Universe Bond Index ETF) fell -5.3% during the calendar year 2021. US bond holders didn’t fare much better, with iShares Core US Aggregate Bond ETF dropping approximately -3.5%. This is among the largest annual drop for bond holders in many years. (3)

Balanced investors generally achieved positive returns, but because of weakness in the fixed income sector their returns were dampened. This can certainly lead to frustration, as all investors would prefer a higher return to a lower one. We only need to look back to 2020, though, to see why fixed income is included in diversified investment portfolios – they prevent the more severe losses that are often seen in equity markets, as we witnessed in March of that year. In prolonged bull markets, it’s sometimes hard to justify keeping exposure to fixed income.

 

Looking Deeper

Human behaviour is fickle, especially when it comes to investing. There is an entire branch of study dedicated to this: behavioural finance. Behaviour financial seeks to account for the cognitive and emotion effects that humans bring to their investment management decision making. It attempts to understand how humans behave in the real world. This is a stark contrast to other economic models, where it is assumed that clients make informed decisions that align with their best interests. What I find interesting about behavior finance is that it does not carve a path forward for decision making, but reveals some of the unconscious biases that we all have. Being aware of these cognitive biases might help us make more prudent and rationale decisions.

Two of the more powerful emotions with respect to investing are fear (especially the fear of missing out) and greed. The fans of these emotions seem to have been flamed throughout 2021, especially since equity markets were doing quite well.

“Fear” is straightforward, and tends to dominate when markets are performing poorly. In the worst case, fear leads to clients selling long-term investments and moving to safe havens like money-market securities. Fear caused many investors to sell long-term assets in March 2020 when the pandemic emerged, sometimes at a loss. By not being invested, they missed the recovery and subsequent growth in their portfolio. Fear can also be the “fear to change” an investment strategy that has worked for a long time, but is no longer meeting needs.

“Fear of Missing Out” (or FOMO in modern vernacular) refers to the feeling or perception that others are doing better than you. They’re having more fun, driving nicer cars, or their investment portfolios are doing better. Social media seems to have made this problem worse, with people showcasing their wins without highlighting their losses. “Fear of missing out” should not be trivialized – it’s a real feeling or apprehension that you aren’t making decisions to make your life better. Recall in 2021 the mania that surrounded Gamestop, cryptocurrency, NFTs or up-start electric vehicle manufacturers. According to Fortune, investors poured $30 billion into the crypto industry in 2021, more than all other years combined. This isn’t to suggest for a moment that these companies or technologies do not have long-term investment potential, only that they have been hyped in the media.

“Greed” is one of the seven deadly sins (along with pride, lust, envy, gluttony, wrath and sloth). When investors get greedy, they abandon the critical thinking that in many cases helped them amass a portfolio in the first place. It’s the difference between “enough” and “more”. During periods of market growth like in 2021, greed tends to dominate. What value is a 10% rate of return if I can get 15% somewhere else?

The way to mitigate the emotional aspects of investing is to have a plan and a strategy. Write it down in an investment policy statement. A good investment policy statement should be backed up by a financial plan – if you don’t have one or would like yours updated, let me know – a periodic update or review is important. That said, an investment policy should be built around specific life goals and the investment strategy that emerges from a long-term approach to investment. This discipline helps control the emotional aspects of investing and acts as a reminder that acting on the emotions of fear and greed can often have long-term negative effects.

 

Looking Ahead

The flip side of strong equity market returns is that we are once again in “unknown territory”. Markets have never been this high, leading some to suggest that we are in another asset bubble that is due for a correction. However, other analysts point out that we are also in unprecedented times, as central governments – despite the US tapering – continue to pour money into the economy through lavish spending bills. The US “Build Back Better” bill will, if passed inject approximately $2 trillion into the US economy, a good percentage of which will find its way to the market either by direct investment, government purchase, or workers investing new-found money.

COVID and inflation continue to dominate markets, and we’ll keep watch of emerging economic data and adjust portfolios accordingly. Right now this is especially a problem for more conservative investors, or for those who have portfolios significantly weighted in fixed income products. For the period ending October 29, 2021, the annual compounded rate of return over a five year period for fixed income (as measured by BMO Aggregate Bond Index ETF “ZAG”) was a mere 2.13%. Over the same period, inflation averaged out to be at 2% (as measured by CPI in Canada), implying a real rate of return of 0.13%.

Fixed income plays a role in portfolios – but in situations like this, its role is to defend from potential equity market declines. Fixed income investors have suffered because their real rate of return has been virtually non-existent over this time.

 

Further Reading

Markets & Investing – Raymond James

Buy-and-Hold Investing vs. Market Timing: What's the Difference?

 

The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.

  1. Data provided by Factset showing the price return of S&P500, S&P TSX, NASDAQ and EURO STOXX 50 for January 1st – December 31st , 2021 in its respective local currency.
  2. Data provided by Factset showing the price return of S&P500 sectors and S&P TSX sectors for January 1st – December 31st, 2021 in its respective local currency.
  3. Data provided by Factset showing the price return of the ETFs “XBB” and “AGG” for January 1st – December 31st, 2021 in its respective local currency.

 

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