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TORONTO — After enjoying a spectacular stock market run this past year, Canadian investors should be prepared for "muted" returns in 2022 as central banks end the stimulus gravy train, experts say.

Candice Bangsund said it's a good time to think about portfolio adjustments.

"We expect a more challenging environment for equities going forward after what's been a fairly impressive rally in 2021," said the portfolio manager for Fiera Capital.

The S&P/TSX composite index was up nearly 25 per cent this year, the best performance since 2009, until fears about the Omicron variant caused a 5.4 per cent drop in the Toronto market in just a few days in late November.

Canada's largest stock market index is up19 per cent as of Dec. 17, well above the long-term average of 9.3 per cent. It follows a 2.17 per cent gain in 2020 and 19.1 per cent gain in 2019.

U.S. stock markets are heading toward similarly strong results in 2021 with the S&P 500 on pace for a 23 per cent gain, Nasdaq at 17.7 per cent and the Dow running at 15.5 per cent.

But as savvy investors know, past performance is no guarantee of future results.

An impending pullback in the monetary and fiscal stimulus that fed the strong market gains, coupled with higher interest rates, are expected to weigh on next year's market performance. 

And bonds, long seen as key to a balanced portfolio, are no longer viewed as a guaranteed good return.

Bangsund said Fiera is recommending its clients shift some of their portfolio into non-traditional asset classes such as private credit, real estate, agriculture and infrastructure.

She also said investors should rotate out of growth sectors of the market that have thrived during pandemic lockdowns — technology foremost among them — into cyclical, value-oriented sectors such as resources and financials where "there's more room to run" in an era of higher inflation, commodity prices, bond yields and interest rates.

Both of those sectors are heavily represented on the Toronto exchange.

"That is really the thesis underscoring our overweight allocation to Canadian stocks versus U.S. stocks heading into the New Year."

Ian Riach, portfolio manager for Franklin Templeton Investment Solutions, also expects a widening gulf between the Canadian and American markets in 2022 because U.S. shares are relatively expensive.

"Valuations are generally more reasonable here in Canada," Riach said during an online event unveiling Franklin Templeton's outlook for 2022. "Lower valuations tend to indicate higher return potential over the longer term."

Like Bangsund, he pointed to resources and financials as likely sources of healthy earnings. Energy prices have surged in recent months while banks have benefited from a steepening yield curve and reduced loan loss provisions.

However, risks remain.Canadian consumers are carrying heavier debt loads than their U.S. counterparts because of a scorching housing market, which "could make us vulnerable to a policy mistake (if) say, the Bank of Canada raises rates too much too early."

But Riachsays what worries him the most are risks that aren't yet known.

"With valuations being high, we may be vulnerable to a larger pullback if something unforeseen arises," he said, pointing for example to volatility earlier this month over concerns about Omicron.

"That so-called black swan event could cause a larger pullback, given where valuations are, and so it's going to make it for an interesting environment."

He said opportunities in the next phase of the market cycle will come from high-quality companies that trade at reasonable valuations and can provide some protection from downside risk should there be a larger pullback.

Even though the S&P/TSX composite has surged 84 per cent since the latest bull market started in March 2020, it still has upside potential, says Mona Mahajan, senior investment strategist at Edward Jones.

Bull markets usually continue unless a recession is on the horizon or central banks are closer to the end of their tightening cycle.

"We don't see either of those conditions in place this year or next year. And so in that scenario, we think the bull market does have room to run, probably at more moderate return levels, than we've seen in the past three years. And perhaps more volatility, but still positive returns," she said from New York City.

"We still continue to believe single digit returns are feasible, but along the way you might get some bumpiness." 

Mahajan foresees market returns coming in next year in line with historical averages and suggests investors use pullbacks and corrections of five to 10 per cent as opportunities to enhance or diversify portfolios.

Allan Small, senior investment adviser at IA Private Wealth, says he's warning clients to prepare for market choppiness as interest rates rise.

"I'm not fearful of that," he said. "History tells us rates and the stock market can go up together at the same time. So I don't think it's a bad thing."

Significantly higher rates in the three to five per cent range would be a "game-changer," but Small said coming off zero to about two per cent shouldn't prevent markets from rallying.

"It'll be bumpy because you know investors are going to get nervous," he said.

"I would look for more normalized returns in the seven, eight per cent range. Anything above that I think is gravy for next year." 

This report by The Canadian Press was first published Dec. 17, 2021.

Ross Marowits, The Canadian Press