January 13, 2022

Financial Letter - March 2022

“The wall of worry”

Since the start of the year, investor confidence has been sorely tested. The war in Ukraine, inflation, high oil prices, rising interest rates, stock market volatility, the arrival of a sixth wave of Covid, all of these factors combined threaten to plunge the global economy into recession. In addition, the inversion of the interest rate curve and deterioration of access to credit (Goldman Sachs index) are early indicators of a recession. Yet despite all this, few of you have contacted us to review your asset allocation. There are several possible explanations for your commendable resilience to this volatility.

Our discretionary management portfolios are performing relatively well compared to their benchmark index. Our management style consists of allocating a significant weighting to growth companies whose stock market valuations are reasonable based on financial ratios (EV/EBITDA, P/S, P/B, P/E, P/CF, P/FCF ,ROE and div yield). In a rising interest rate environment, capital flows to companies with reasonable valuations that are able to return some of their profits to investors in the form of dividends, share buybacks or debt reductions.

Your years of investment experience have likely taught you that market corrections are frequent and unpredictable. Over the past 40 years, the average annual decline in the US index was -13%! Despite those setbacks, the US stock market took a few months to regain lost ground and ended the year positive more than 80% of the time. Given the high frequency and unpredictability of market corrections and the speed at which the  market rebounds, it’s futile to try to avoid stock market corrections. As time passes, volatility simply becomes a reality that you have to learn to live with.

During volatile times, reviewing or updating your financial plan can be helpful. While you may have set the plan up primarily to meet your retirement goals, it can be reassuring to see that the last few years have allowed you to get ahead. Reviewing your financial plan can also be useful for identifying tax-saving strategies, addressing your financing needs (real estate purchases) or doing estate planning.

Despite yellow flags on some economic indicators, the macroeconomic backdrop remains positive for 2022. Global economic growth is slowing but still above potential, and estimated corporate earnings growth, while under pressure, is 8%. In the United States, job demand exceeds  worker supply by some 5 million people and consumers have a savings surplus of $2 trillion. Will rising wages and inflation cause retirees to return to work and thus  increase the participation rate ? The manufacturing and services PMI indices are expanding, and interest rates will rise gradually (6 increases). We’ll pay close attention to the capacity of the companies in the portfolio to maintain their profit margin in this inflationary environment.  In a context of rising rates, inflation and contraction of the price/earnings ratio, our expertise in selecting individual securities can be a source of added value.

Overall, this economic and financial backdrop favours maintaining your weighting in equities (especially value stocks) and underweighting bonds, or at least in the duration of maturities, since bond prices vary inversely to interest rates. The Global Total Return Bond Index is currently having its worst run since results were first compiled in 1990. This 11% fall equates to a drop of about $2.6 trillion in the global bond market value. Nevertheless, bonds play a stabilizing role in the portfolio when the economy goes into recession, just like an insurance policy for an unforeseen event.