hot air balloon

Canadian investors should expect a second consecutive year of equities gains and negative returns for bonds as the pandemic creates a “new market regime,” a report from the BlackRock Investment Institute says.

While the Bank of Canada is set up to raise rates sooner than other central banks, Canada is not alone in the new regime, according to the institute’s 2022 outlook. BlackRock expects global stock gains and negative bond returns for the second year in a row, which hasn’t happened since data was first collected in 1977.

“This unusual outcome is the next phase of our ‘new nominal’ theme that is still playing out: Central banks and bond yields are slower to respond to higher inflation in the powerful restart than in the past,” said the report released Monday.

“That should keep real or inflation-adjusted bond yields historically low, and support stocks.”

Canada’s solid labour market and strong economic growth outlook mean the Bank of Canada can start raising rates ahead of other developed markets, BlackRock said. The BoC ended asset purchases in October and the bond market has priced in four rate hikes by the end of 2022.

Canadian stocks should still perform well next year, the report said, though gains will be more modest than this year’s. As of Friday, the S&P/TSX Composite index had returned almost 20% this year.

“The pace of profit growth is set to slow as the restart matures, but Canadian stock multiples have cheapened during 2021 as earnings growth outpaced stock market gains,” the report said.

The bond story was very different, and that will continue next year as the Bank of Canada unwinds emergency support and real rates stay near historic lows, the report said. BlackRock is underweight Canadian government bonds, preferring inflation-linked bonds and private credit.

The “unprecedented nature of the economic restart” and challenges of interpreting central bank policy — the Federal Reserve’s average inflation targeting, in particular — mean BlackRock is trimming its risk.

“We overweight developed market stocks versus emerging market equities, and favour inflation-linked bonds partly for diversification,” the report said.

The global recovery may be delayed by new virus strains, but not derailed, BlackRock said. Central banks will raise rates but remain more tolerant of inflation, allowing it to settle above pre-Covid levels.