Both equity and fixed income markets saw significant volatility in the first quarter of 2022. Most major central banks around the world maintained their hawkish stance to tackle unsustainably high inflation. The Bank of Canada (BoC), U.S. Federal Reserve (“the Fed”), the Bank of England (BoE) and European Central Bank (ECB) began removing stimulus measures to address the persistently high inflation. The BoE, the Fed and BoC made the first in what is expected to be a series of policy rates hikes. Geopolitical risk and uncertainty were on top-of- mind over the quarter, particularly after Russia’s invasion of Ukraine. Western countries have responded by implementing trade sanctions on Russia. The sanctions have caused a substantial decline in economic activity in Russia and deteriorated the value of the Russian ruble. Russia is a key global supplier of commodities including energy, fertilizers, and base metals. Trade restrictions have in turn raised commodity prices globally.
In Canada, the S&P/TSX Composite Index gained 3.8% during the first quarter of 2022. From a sector perspective, the Energy, Materials and Communication Services sectors experienced the strongest growth, with gains of 28.7%, 20.1%, and 8.8%, respectively. Growth stocks retreated and ended the quarter down 3.7%, while value stocks performed well and pushed higher by 10.4%
Canadian stocks benefited from a sharp rise in oil and commodities prices. WTI crude oil was up a remarkable 32.0% in the quarter. The S&P 500 Index (C$) lost 5.7% in the first quarter, with heavyweight sectors like Consumer Discretionary, Information Technology and Healthcare all posting negative returns. In global stocks, the MSCI World Index (C$) declined by 6.2% with large sectors like Consumer Discretionary, Information Technology, Financials and Healthcare all posting double digit negative returns.1
The Canadian bond market pulled back sharply, with the FTSE Canada Universe Bond Index down 7.0% in the first quarter. Bond yields spiked in the quarter on rising inflation, interest rate hikes and increasingly hawkish commentary from global central banks. In Canada, federal government bonds outperformed corporate bonds over the quarter reflecting investors’ decreased risk appetite.
If central banks really want to get their inflation rates down, then a recession would do it. The inflation rate usually gets cut in half during a downturn, but with that also goes employment, corporate profits, house prices, and the equity market. This is not meant to be a forecast, but these dynamics are something to be mindful of as we continue to monitor the evolution of monetary policy decision making.
The base case scenario, as we see it, is to prepare for higher interest rates and positive, albeit much slower, global economic growth over the next year relative to what has been delivered over the prior year.
The trajectory for inflation, central bank policy settings, and the war in eastern Europe have placed downward pressure on equity valuation multiples. This de-rating has more than offset the benefits from the ongoing advance in corporate earnings. Based on earnings estimates compiled by FactSet, S&P 500 index earnings per share (EPS) is forecast to increase by about 10% annually this year and next to new highs of $223.68 in 2022 and $246.49 in 2023. U.S. companies have been raking in the profits as they have been able to pass on rising input costs to maintain their profit margins. In fact, profit margins are at record highs, despite steep price increases for commodities and raw materials, and higher labour, energy, and transportation costs. TSX Composite EPS is projected to grow at a slower pace but still reach record highs, rising 9% to $1,467 in 2022 and $1,551 in 2023. Absent an imminent economic recession, global corporate earnings per share are likely to continue tracking an upward trajectory.
The global bond market has not offered multi-asset portfolios a source of performance stability that was commonplace over prior years. Whether it’s sovereign bonds, or corporates, most areas of the fixed income market have struggled to perform this year. Nowhere is this more evident than in the long-dated segment of the bond market, regardless of the credit rating. Just imagine how the holders of a supposedly safe Austrian AA-rated 100-year government bond are feeling after the 56% decline seen in its price over the past year.2 The backdrop continues to favour shorter-dated corporate bonds within fixed income portfolios until there are more visible signs that global inflation has passed its peak.
As economic growth continues to slow, we expect the performance spread between stocks and bonds to narrow but to remain in the equity market’s favor. As the economic and market cycle matures, earnings reliability and balance sheet strength usually become more important performance attributes. This dynamic encourages a geographic tilt toward the U.S. equity market and sectors such as Healthcare and Consumer Staples. Maintaining sizable exposure to alternative investments is important.
The crosscurrents from war, inflation, and central bank policy tightening encourages exposure to asset classes which behave differently than stocks and bonds. The key idea for the alternatives sleeve is to add independent return streams to enhance the reliability of the portfolio’s aggregate performance profile in the event of unforeseen circumstances. Including some exposure to real assets, such as commodities, dampens the risks associated with further increases in inflation. Other ideas include long-short strategies in either fixed income or equities.
The revered Warren Buffet’s all US equity portfolio has grown 9.64% annually over the last 30 years, as of April 30th, 2022, it came with a 55% drawdown during this timeframe, much too high for most investors. However, a 55% Geographically diversified Equity and 45% Fixed Income basket returned 7.91% but with a more palatable 31.78% drop over this same timeframe of the last 30yrs.3 Adding commodities and alternative strategies further mitigate volatility to within range of an average investor’s risk appetite.
As always, thank you for your continued trust in us.
Penmore Wealth Management
This information has been prepared by Roland Orban who is a Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.
iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.
- Dynamic Funds-First Quarter Commentary
- Dynamic Funds-The Investment Junction (April 2022)
- www.lazyportfolioetf.com
Roland Orban, CIM, PFP, Investment Advisor
304-3301 Langstaff Rd, Concord, ON L4K0C5
T: 905-669-5577 Ext. 230 | TF: 1-866-229-2212 | F: 905-669-5738
roland@penmore.com | http://www.iaprivatewealth.ca | penmorewealth.com
