The Back Half (of 2022)

June 30, 2022 | Mike Allington


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The past few weeks have seen a noteworthy development with inflationary concerns overshadowed to some extent by growing fears around a recession. With the first half of 2022 coming to a close, we provide some thoughts on the second half of the year.

The past few weeks have seen a noteworthy development with inflationary concerns overshadowed to some extent by growing fears around a recession. Most notably, this has resulted in some weakness in commodity markets such as oil, copper, and wheat, which have all fallen of late. Meanwhile, bond yields have moved lower (and prices higher), while stocks have been somewhat less noticeable, oscillating back and forth without clear direction. That has brought the first half of 2022 to a close. Needless to say, it’s been a period that most investors would like to forget. Below, we provide some thoughts on the second half of the year.

 

Our firm’s investment team regularly publishes thoughtful commentary that we read quite regularly. They recently published a Midyear Outlook, in which they discuss the vulnerabilities that remain. The team outlines two scenarios: one in which inflation remains stubbornly elevated, forcing central banks to continue to tighten financial conditions, and the other in which inflation recedes, the economy slows, and the need for more tightening declines. The outlook is worth a read.

 

We concur that challenges remain for the second half of the year. But, we are hopeful inflation may peak at some point and start to decline from today’s elevated levels. The potential drivers range from lower demand, to some improvements in global supply chains, and the potential for more subdued commodity prices. Moreover, the base effects of year over year comparisons may lead to a natural slowing in the rate of inflation. The levels will remain uncomfortably high, but in time, a falling inflation rate may result in less volatile market conditions, and a potential return to the more typical behaviour and relationship we have witnessed between stocks and bonds.

 

The pendulum of rate hikes swung to an extreme this year, with central banks feeling the need to raise rates aggressively. This drove much of the volatility in the equity and bond markets. Should inflation recede, it could open the door to the possibility that central banks may not have to raise rates as much as markets expect. That alone could prove to offer some better support for capital markets.

 

Economic growth is slowing and may likely continue to trend in that direction given the tightening of financial conditions. As a result, recession risks may continue to rise. Surprisingly, earnings expectations for the year ahead have not meaningfully adjusted, and we suspect they will have to be reduced to reflect the deteriorating backdrop. That may be an emerging source of vulnerability for equities through the latter part of the year. Yet, weaker growth, or an outright recession, may be what’s needed to help drive inflation sustainably lower.

 

The period of uncertainty, volatility, and market weakness appears poised to continue for a little while longer. Our approach remains centered on building investment plans that can deliver on the long-term needs of our clients with the expectation that we will have to deal with periods like this from time to time. After all, markets don’t always move higher. But, history has taught us that investors are more likely to succeed in achieving their long-term financial goals by staying disciplined and committed to their financial plan. That has, and remains, a guiding principle of ours.

 

We want to wish all of our clients a happy Canada Day and a great summer. We will continue to monitor your portfolio and market developments closely, and provide updates on a regular basis. Should you have any questions, please feel free to reach out.

Mike


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