Looking back
“Unprecedented” was a word many of us added to our vocabulary at the start of 2020 as COVID-19 spread around the world, resulting in lockdowns and other changes to our “normal” lives. Just as we all thought we’d heard the end of the word with pandemic restrictions easing, inflation continued to creep higher throughout 2022, in turn forcing global central banks to raise interest rates at an “unprecedented” pace and size. In addition, the war in Ukraine, a strong U.S. dollar, rolling COVID lockdowns in China, and a pension crisis in the UK certainly made 2022 a year to remember. Market volatility was elevated through much of the year for every asset class – commodities, bonds, stocks, cash and currencies - with really no places to “hide” in the short term.
In challenging times, we believe that it’s important for investors to maintain perspective and recall that the previous five years generated higher-than-expected returns for almost all asset classes. With the exception of calendar year 2018, global equity markets returned between 14.1% and 24.7% in Canadian dollars from 2017-2021.
High volatility was the theme in Commodity asset classes during 2022. Some key drivers of this center around recession fears, the ongoing war in Ukraine and a strong U.S. dollar. Oil prices have continued to fall through the latter part of 2022 as a result of recession fears (i.e., reduced demand), while natural gas prices remain elevated from the beginning of the year as a result of the war in Ukraine (i.e., reduced supply). While gold historically has been thought of as an inflation hedge, in 2022, this wasn’t the case, as gold was negatively impacted by higher real interest rates and a rising U.S. dollar.
Equities declined globally, largely due to higher interest rates impacting the valuation of most stocks. While the U.S. and emerging markets, measuring in Canadian dollar returns, entered an official “bear market” in 2022, Canadian equities outperformed other major indices as a result of higher commodity exposure. And finally in 2022, it was certainly an unusual year for Fixed Income. Unrealized losses, due to market values of existing fixed income investments going down as interest rates on new fixed income investments went up, were at “unprecedented” levels normally associated with stocks during a bear market.
Looking forward
We believe that global growth will continue to slow into 2023 as a consequence of the cumulative monetary policy tightening by global central banks. A recession in Canada and the U.S. may indeed be in the cards for the coming year. Prominent indicators of a recession have been flashing “yellow” and “red” since the midpoint of 2022. More recently, the U.S. Conference Board Leading Economic Index, a prominent signal for economic forecasting, hit eight straight months of declines to the end of October 2022. Moreover, further evidence of slowing growth can been seen across the global manufacturing sector. Since the beginning of the year, various leading indicators for manufacturing activity have also signaled a forthcoming slowdown.
On the positive side, more recent data shows signs of slowing inflation. While the macroeconomic environment remains highly uncertain, as we look out over 2023 there are signs that inflation could continue to fall. These include falling or stagnant commodity prices, slowing rent increases, easing global supply chain pressures and declining manufacturing input prices. With growth running at a modest pace, central banks may begin to normalize monetary policy in mid-2023, laying the groundwork for an extended global expansion. However, it’s also quite possible that some of the above near-term signals of slowing inflation may reverse at some point, giving the central banks reasons to continue raising interest rates above market expectations; or, at the very least, keeping interest rates higher for longer than expected.
Putting it together
In terms of portfolio asset mix, at today’s higher interest rates, we see fixed income investments offering more attractive forward-looking returns than in recent history. In addition to providing investors with higher yield today without taking on undue portfolio risk, bonds have typically been a portfolio ballast in the event of a recession or economic slowdown. As such, we would be reducing any portfolio underweight in fixed income today, looking to government and investment-grade investments, while considering additional portfolio weight in high-yield fixed income as credit spreads widen out into 2023.
Over the long term, we expect equities will outperform bonds, however we are recommending that investors remain closer to strategic neutral targets in portfolios over the near term. The risk of a declining corporate profit outlook in U.S. and Canadian equities remains a near-term risk to the equity markets for those with a shortened time horizon. Long-term investors should continue to take advantage of systematic dollar-cost-averaging to add equity weight in their portfolios as prices fluctuate.
For additional perspective and details on our outlook for 2023, please refer to our Special Report (link), or reach out to your Investment Counsellor to receive a copy.
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