After 20 months of growth, the start of 2022 saw increased volatility in global markets which was exacerbated by Russia’s invasion of Ukraine.
Stock, bond, and commodity markets had already been grappling with pandemic-related problems of inflation, supply chain disruptions and the prospect of higher interest rates when Russian troops moved into Ukraine on February 24.
Fears the invasion would amplify those challenges sent stock markets lower in late February and into March. Outbreaks of COVID in China that provoked harsh lockdowns further added to market worries.
Amid a general pullback in the global markets, the Canadian stock market was one of the few bright spots during the quarter. Russia is a major supplier of oil and gas and industrial metals, while Ukraine is a key exporter of wheat and other foodstuffs. The prospect that supplies of these commodities would be curtailed sent prices higher, to the benefit of the Canadian stock market.
When things seemed gloomiest in mid-March, glimmers of hope suddenly appeared that a negotiated end to the violence in Ukraine might be found and that the U.S. Federal Reserve would take tough action to tame inflation.
Those perceptions helped the U.S. and international stock markets to recover lost ground in the latter part of March. It was another example of how quickly stock markets can turn around in response to new developments.
Of course, we have no way of knowing where the markets will go from here but the lesson once again from this latest episode of volatility is that if you wait on the sidelines for tough times to be over, you may miss out on a powerful recovery. It’s always better to stay calm and stay invested.
At quarter’s end, the Canadian stock market was up about 3.8% since January 1st, while the U.S. market was down 6.3% and developed international markets were 7% lower. Emerging markets were off 8%. All returns are in Canadian dollar terms.
One piece of good news for our clients was the relatively strong performance of small value stocks in all markets. Despite a bad start to the year in equity markets, we’re getting a small value premium to offset some of the downside, thanks to our philosophy of tilting portfolios in that direction.
Also of note during the quarter was the movement, or lack thereof, of the Canadian dollar. Despite a surge in the price of oil to over US$100 per barrel, the dollar actually fell against the U.S. greenback in the early stages of the Russian invasion, before recovering in the latter part of March. This contrasts with what we’ve come to expect during other oil price rallies when the loonie gained ground against the U.S. dollar.
The reasons for the loonie’s failure to launch this time are a matter of conjecture. It could be related to the U.S.’s emergence as the world’s leading oil producer, thanks to the hydraulic fracking revolution over the last decade. Or it could the result of a perception among investors that the U.S. will increase interest rates faster than Canada this year.
The timing of future interest rate hikes might be up for debate, but it seems highly likely they will happen. Both the U.S. Federal Reserve and the Bank of Canada have been clear that they will increase their trend-setting rates multiple times this year in an attempt to bring down inflation.
Inflation has been higher and more persistent than they initially predicted. The consumer price index has hit levels not seen in decades on both sides of the border, rising in February to 5.7% year-over-year in Canada and 7.9% in the U.S.
Both the Bank of Canada and the Fed have so far raised rates by a quarter of percentage point and observers are forecasting more increases ahead, with the U.S. central bank expected to raise its rate by a further half a percentage point at its next meeting in May.
And interest rates are not the only weapon in inflation-fighting arsenal of the central banks. Since the financial crisis of 2008/9, they have purchased massive amounts of government and corporate bonds to stimulate the economy. Now, they may be preparing to reverse course and start selling some of those bonds.
This so-called ‘quantitative tightening’ is another way central bankers can effectively put upward pressure on interest rates to cool the economy and inflation. The challenge will be for central banks to do so without causing a painful recession.
For an enlightening discussion of the current inflation picture, you can listen to New York Times journalist Ezra Klein’s interview with former Treasury Secretary Larry Summers whose early warnings about inflationary pressure building in the economy have so far been vindicated.
In the first quarter, rising rates sent fixed income markets sharply lower (bond prices and interest rates move inversely). The Canadian bond market fell 9.5%.
We have buffered client portfolios from rising rates by shortening bond maturities to reduce interest rate risk.
We are also having conversations with all clients about the appropriate exposure to bonds in each of your portfolios. We believe portfolios should hold enough bonds to secure your spending needs for the next several years but not more than necessary.
As always, don’t hesitate to reach out if you have any questions.