Outlook Less ‘Rosy’ Than Some Predict

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Avery Shenfeld

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Avery Shenfeld, chief economist at CIBC.

If you look at what economists are forecasting, or even what companies are forecasting for their own earnings growth over the next couple of years, it does look like a fairly rosy scenario. The service sector is seen as making a more complete comeback than it has so far. Global economic growth is expected to improve as vaccinations cause Covid to decelerate around the world. Generally a sunny outlook.

But while economists are often called the “dismal science,” it’s really epidemiologists, those who track infectious diseases, who deserve that title. Because when you look at what they’re saying about the outlook for Covid ahead, it isn’t as uniformly positive as what most are assuming. So the biggest downside risk is that we still face further waves of Covid-19. New variants emerge that have the same property perhaps as Omicron, the ability to break through people who have had vaccines or prior infections. And even worse, perhaps we could have a variant that also combines some of the greater lethality that we saw for example with the Delta variant.

That sort of combination or even a milder version of that will see the economy suffer some setbacks along the way to those better economic times – setbacks that I don’t think the markets are fully allowing for in some of these projections. Particularly so for the service sector, where in order to get full confidence back in sectors like travel and restaurant dining and so on, we need not just a period of sunshine on the virus, but I think we’ll need a longer period in which we don’t see further waves that cause trouble and allow those sectors therefore to stay up and running on a more sustained basis than we’ve seen so far.

What this means for investors, particularly those investors who have been heavily weighted in equities and seen their equity prices appreciate and therefore equities take a larger and larger share of their portfolio, is that it’s still time to have a little bit of downside protection in one’s portfolio. So that would include some bond holdings, for example, that may not perform very well in a sunnier economy, but which will provide, at this point, some downside protection should the economy be hit by further waves of the virus.

I’d be remiss if I didn’t mention some other downside risk. We have geopolitical risk as we speak in mid-February. Certainly the situation between Russia and Ukraine is not yet clear. In addition to that, oil could go either way quite dramatically depending on how talks between the U.S. and Iran over nuclear issues are resolved. So there’s some potential volatility in certain sectors relating to other developments in the global economy that bear watching.

And again, for investors that means keeping an eye on your balanced portfolio. And for the companies that you’re investing in, it’s probably prudent to ensure that those companies are also keeping some resiliency on their balance sheet in order to handle perhaps some months or quarters where the economy doesn’t perform quite as well as economists are now expecting. I should say that even with rising interest rates, we do expect that equities as an asset class could still outperform bonds in our base case scenario. That simply could be because of the dividends exceeding the coupons on those bonds and even if the equities, in other words, don’t move much in value. But at all times, one has to think about balance in a portfolio. And especially given that we’re still dealing with a virus, which has its mysteries in terms of where these new variants come from, whether we’ll face further ones in the future, it behooves investors to keep an eye on a balanced risk perspective in order to ensure that you can live to see a brighter day when the virus, hopefully, truly does start to disappear from our lives on a more permanent basis.