First quarter of 2022

Hello everyone,

We can sum up the first 3 months of the year in one word: volatility. Whether it was in the equity or bond market, the first quarter of 2022 triggered a lot of emotions. Geopolitical tensions, rising inflation, the pandemic, tighter monetary policies and interest rate hikes were the main causes.

Geopolitical tensions

On February 24, Russia attacked Ukraine on the order of Vladimir Putin, setting the stage for significant human and economic impacts. NATO countries responded by imposing heavy sanctions on Russia and a number of multinationals followed suit by shutting down operations in that country. In addition to the humanitarian toll, this conflict has created considerable uncertainty on global stock markets and has further impacted the energy market. The price of a barrel of oil jumped 34%* in the days after the invasion, reaching a peak of $124.77. Over the quarter, per-barrel prices were up 34%, going from $75.99 at the start of the year to $101.20 on March 31.* This sharp increase complicates the task of central banks trying to curb inflation. A resource price surge of this magnitude puts upward pressure on inflation in the short term.

*Source: Market-Q

It's worth noting this type of geopolitical conflict doesn't tend to affect stock markets for long. As shown in Chart 1 below, the day of an invasion has historically been a pivot point for the stock market.

Inflation, tighter monetary policies and higher interest rates

Since the start of the year, these 3 factors have been evolving in tandem. For starters, rising energy prices, supply chain issues and supply shock in the market are propelling inflation to levels not seen in 40 years. To put a damper on inflation, the central banks have to take action and the main tool they can turn to is higher benchmark rates. Indeed, the US Federal Reserve is forecasting 6 key rate hikes in 2022 and the same is expected in Canada.

Why does that have an impact? One of the consequences is that interest rates are trending up in the bond market. As at December 31, 2021, a 10-year Canada bond carried an annual interest rate of 1.42%. By March 31, 2022, that rate was 2.40%, a spike of about 70%.* Since the value of a bond decreases as the interest rate rises, the Canadian bond index posted its worst quarterly return in more than 40 years, with a loss of 6.97%. As a result, the safest asset class in the portfolio generated the most volatility for us.

*Source: Bank of Canada (https://www.bankofcanada.ca/rates/interest-rates/canadian-bonds/)

Even though bond yields have been strongly negative in recent months, bonds still play a primary role in managing a portfolio. During equity market turbulence, bonds act as a stabilizer in the portfolio, limiting losses while also maintaining the regular income that this asset class provides. It's very rare for bonds to move in the same direction as the equity market.

Can bond rates continue to climb? Yes, but we believe the largest share of the run-up is now behind us, with the market already having priced in central bank projections.

North American equities

As was the case last year, North American equities have outshone their international and Asian counterparts. Although the US equity market had its worst start to the year in history, it recovered in mid-March to end the quarter down 5.86% (S&P 500 index return in Canadian dollars). It's important to note this kind of volatility isn't unusual in an economic cycle. Since 1980, the average intra-year decline has been just over 14.0%. Nevertheless, in slightly more than 3 years out of 4, the S&P 500 ends in positive territory.

Only Canadian equities ended the quarter with a gain of 3.82% (S&P/TSX index return) given the market's overexposure to the energy, materials and financial sectors, which were the strongest performers in the past 3 months. The soaring price of oil and other commodities has enabled the Canadian market to stand out.

International and emerging market equities

Once again, international and emerging market equities underperformed North American markets. At the international level, widespread geopolitical tensions and sanctions imposed by NATO countries have created an atmosphere of instability and uncertainty. That said, it's important to keep those holdings as part of a well-diversified portfolio. In a higher interest rate environment characterized by strong inflation, international markets could stand out in the coming months because of their large contingent of value stocks. In addition, the recent declines have fostered many buying opportunities, which is key to proper rebalancing.

In China, the 2021 downturn continued into 2022, mainly due to the pandemic (which is still wreaking havoc in Asia) and the country's zero-COVID policy. Various major cities have been shut down following a few cases of COVID-19, which has led to scalebacks in factory production and supply chains. However, unlike central banks in North America, the People's Bank of China is in the process of lowering the country’s benchmark rate to stimulate the economy. Some emerging market mandates have not performed up to par in the last 18 months, but this now represents a good opportunity for growth.

Conclusion

According to our Investment Strategist, Jean-René Ouellet: "Earnings growth will certainly slow in 2022 but should still remain comfortably in positive territory. Given the state of household finances, government willingness to spend and business investment intentions, it seems fairly unlikely a recession will occur in the next 12 to 18 months. A recession will come ... but it seems premature to be talking about it right now. In short, downward fluctuations are an integral part of the investment cycle and should be considered opportunities to demonstrate our investment discipline and rebalance our portfolios."

As a final point, we think it's useful to recall the 6 essential rules for periods of turbulence. Fluctuations are here to stay and our duty is to stay focused on your current and future financial goals. We encourage you to read the 2 attached texts, which we believe are very relevant given the recent fluctuations.

You can always count on us to take care of your wealth.

Thank you very much, and have a great spring!

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