Analysts and economists are taking widely divergent views on 2022.
At one end of the spectrum is JPMorgan Chase, which said in its annual global economic outlook that this year will see an end to the pandemic and a stock market boom.
“Our view is that 2022 will be the year of a full global recovery,” said Marko Kolanovic, the company’s chief global markets strategist, in a note to clients last month. “This is warranted by achieving broad population immunity and with the help of human ingenuity, such as new therapeutics expected to be broadly available in 2022.”
The result, the company’s report said, will be a “strong cyclical recovery, a return of global mobility, and a release of pent-up demand from consumers.”
Great news! But – there’s always a but. “If COVID-19 were to have a prolonged impact – into the medium term – it could reduce global GDP by a cumulative $5.3-trillion over the next five years relative to our current projection,” said International Monetary Fund chief economist Gita Gopinath.
Ms. Gopinath made her comments in October, before anyone had heard of Omicron. Now, just a few months later, the latest variant is sweeping the world, hospitals are under siege, workers are calling in sick and supply chains are under renewed pressure. Suddenly, the outlook doesn’t look quite as rosy.
The reality is that 2022 is a huge question mark, with much depending on the course the coronavirus takes over the next few months. If Omicron turns out to be the last major wave, the glowing predictions from JPMorgan and others could become a reality. But if the virus mutates again and becomes more dangerous, anything can happen.
In the face of this uncertainty, what can income investors do to protect their portfolios? Here are some dos and don’ts to consider.
Don’t sell quality
Unless there is a dramatic change in direction, interest rates will rise in 2022. The U.S. Federal Reserve Board has already signalled that it expects to implement three hikes this year and will start to trim its balance sheet. Many observers believe the Fed will actually raise rates four times. The Bank of Canada hasn’t made any announcement yet but will likely do so soon.
The reason: inflation, which is now running at levels we haven’t seen in years. The effect of rising rates will be to undermine one of the market’s main support pillars, which in turn could lead to a sharp correction.
Many income stocks will probably decline in price as a result. The pressure on them will be exacerbated because higher yields on fixed income securities will make them more competitive for investors seeking yield. Real estate investment trusts, fixed-rate preferred shares and utilities could be especially vulnerable in this situation.
If this scenario unfolds, don’t panic and sell. If you’re holding quality securities, they’ll continue to pay their dividends/distributions. Ignore the day-to-day price movements. The market will eventually change direction again and valuations will recover.
Do buy bank stocks
As a rule, the stock market hates rising interest rates. But there is a notable exception – banks. Higher rates mean enhanced net interest margins (NIMs). This measurement compares the net interest income generated from credit products such as loans and mortgages with the interest paid for savings accounts and guaranteed investment certificates. The greater the NIM, the more profit a financial institution will generate from its lending activities. Low interest rates squeezed NIMs, but with rate rises pending the margins are about to improve.
There’s another factor at work. From March, 2020, until late last year, financial institutions were ordered to suspend dividend increases and share buybacks by the Office of the Superintendent of Financial Institutions. That prohibition was lifted in early November, with a directive to the banks to be “prudent” with their increases. Most responded accordingly, with the one exception being Bank of Montreal (BMO-T), which implemented a 25-per-cent increase. That suggests the other banks have a lot of room for catch-up.
With enhanced NIM driving profits higher, look for more bank dividend increases this year. BMO, which is one of our recommendations, may stand pat – its stock is up 43 per cent in the past 12 months. But I expect more moves from the others. Canadian Imperial Bank of Commerce (CM-T) looks like a good choice. It raised its quarterly dividend by 10.3 per cent in December, to $1.61 ($6.44 a year) to yield 3.9 per cent at the current price.
Don’t chase unusually high yields
If you come across a security with a yield of more than 10 per cent, be suspicious. No one gives money away. If the yield is that high, there is probably some underlying risk that may not be apparent at first glance.
I recently came across a small mining royalty company, Newport Exploration Ltd. (NWX-X), that is yielding 16.8 per cent, after doubling its quarterly dividend to 2 cents a share last year. The business looks sound, with no debt. But it’s a penny stock (it trades on the TSX Venture Exchange), and it operates in a volatile sector. It may turn out fine for investors, but a yield that high reflects the risk the market is reading into its prospects.
Do buy on dips
If, as I expect, we experience a correction this year, take advantage of the opportunity to add more blue-chip income payers at bargain prices. The telecoms are one sector to keep an eye on. BCE Inc. (BCE-T), for example, is just a shade off its all-time high, and is still yielding 5.3 per cent. Any slippage would be a signal to add more. It is highly unlikely that conditions would get so bad that the company would cut its dividend.
Don’t ignore bonds
Yes, higher interest rates are bad news for bonds. But they add stability and diversification to your income portfolio. Keep risk to a minimum by focusing on short-term issues.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe
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Gordon Pape