- Fuelling the inflation fire
- Commodity consequences
- Portfolio implication
The world continues to recover from the global pandemic, which saw Canadians face two years of various stages of lockdowns, masking regulations, and job stress. We worried about the effect of these on our, and the global, economy and flow-through to capital markets. Counterintuitively, markets – and equity markets in particular – had been resilient and, in fact, rewarding. Ironically, now that the worst of COVID-19 appears to be behind us, there are some serious concerns regarding global growth.
Fuelling the inflation fire
Higher inflation levels, which were expected to be temporary, are now feared to be more of a long-term threat partly due to a war in mainland Europe that was largely unforeseen at the beginning of 2022. Apart from the tragic human cost, the international economic sanctions on Russia have resulted in supply constraints in several commodities, with their prices spiking as a result. This has added fuel to the inflation fire, which has central banks worldwide increasing their interest rates in an attempt to moderate the impact and restore consumer confidence. Oh, for the simpler times of a global pandemic!
In this macro environment of central bank tightening (increasing interest rates), market participants reassess their expectations for the near and medium term. The slowing economic growth associated with higher interest rates gets factored into stock valuations, and companies that had expected rapid growth in the short term are revalued by investors – sometimes dramatically. We’ve seen this in Canada and worldwide within the technology sector, where high growth is expected and valuations dependent on it have been slashed.
On the flip side, as mentioned previously, commodity prices are soaring. Oil, for instance, was practically given away at the outset of the pandemic and is now trading around $100 a barrel. Ukraine, a significant global grower of grain, has largely been removed from those markets, pushing up the price of agricultural commodities like wheat. In concert with that, fertilizer prices have moved sharply higher from levels that were already near cycle highs due to sanctions on both Russia and Belarus, two major producers.
These two recent trends of downward pressure on growth stocks, combined with upward price pressure in oil and commodities, have been a relative positive for the Canadian stock market. As seen in figure 1 below, since the beginning of 2022, the Canadian benchmark (S&P/TSX Composite) index has outperformed both the U.S. (S&P500) and International (MSCI EAFE) benchmark indices.
Figure 1: Global Equity Indices ROR, $CAD
The structure of our market is more heavily weighted towards energy and materials stocks, and less weighted toward technology and health care than either U.S. or international markets. In figure 2, we can see the relative structures of these markets, with the sectors ordered by their performance. The strongest year-to-date performers are shown to the left, progressing to the weakest performers to the right.
Figure 2: Benchmark Sector Weights
Source: Bloomberg, MSCI
At times, the Canadian market has been criticized for this structure from an investment perspective as being insufficiently diverse. We believe diversification takes place at the portfolio level through actively managed portfolios, such as ours. Furthermore, having been well-diversified for the long term, we’re benefitting from the current sectoral forces without having to chase or avoid them. This is important, as being overexposed to any of these themes is not without risk. They can correct sharply and trying to time that has always been a mug’s game.
Uncertainty remains high as the mood has quickly turned from one of pandemic recovery to concern for global inflation and growth. Though we can’t predict the immediate future, as seasoned investors, we know that exercising the patience and discipline to stay in the market through these turbulent times ultimately results in prosperity during the recovery. Being diversified across different geographies helps maintain this discipline.
Sources: Bloomberg, MSCI