July 15, 2022

Financial letter, Summer 2022, 60^th edition

Time to turn the page on the first half of the year

Investing has always meant dealing with surprises and unforeseen variables, and the current uncertain environment calls for a balanced investment strategy. It's not about avoiding the storm—it's about building portfolios that will be strong enough to navigate through it.

Index		Level	3 months	6 months	1 year
S&P/TSX		18,861.36	-13.19%	-9.85%	-3.81%
S&P 500 (USD)		3,785.38	-16.11%	-19.97%	-10.64%
MSCI Emerging Markets (USD)		1,000.67	-11.40%	-17.57%	-25.08%
MSCI World (USD)		2,546.49	-16.06%	-20.28%	-13.92%
CAD/USD exchange rate		0.78	0.80	0.79	-3.69%
FTSE/TMX Short Term Bond		730.29	-1.46%	-4.39%	-4.79%
FTSE/TMX Mid Term Bond		1,145.97	-4.84%	-11.34%	-11.06%
Gold (USD)		1,807.27	1,937.44	1,829.20	2.10%

Economic scenario

Supply chain disruptions and the fallout from the war in Ukraine continue to take a toll, exacerbating inflationary pressure all over the world. Oil prices will remain very high over the coming months. The pandemic is still very much with us, especially in China, where lockdowns undermined economic activity in the second quarter.

The possibility of overtightening monetary policy has emerged as the main risk to the global economy. Amid high inflation and tight labour markets, aggressive rate hikes by the Federal Reserve, the Bank of Canada and other central banks could tip some economies into recession. Europe's economy looks especially precarious due to high energy prices and geopolitical tension from the war in Ukraine. Countries like Canada and the United Kingdom with high household debt are also particularly vulnerable to rising borrowing costs as they’re more sensitive to higher interest rates.

Investment and volatility

Investing comes with its share of unforeseen variables and shifts. Investing well isn't just about intelligence. You also need to be able to stomach periods of greater volatility when they arise.

Even with the best intentions in the world, there's no substitute for a balanced portfolio that's robust enough to handle a range of economic environments.

Long-term investors in particular have to be prepared for more severe market slumps. However, the biggest challenge they'll face isn't the bear markets themselves, but rather the risk of making the wrong investment decisions during these episodes. A different approach to decision-making is needed during market downturns.

To succeed as an investor in the long term, you need to be able to navigate through economic storms. Bear markets are inevitable and a normal part of the economic cycle. Unless you live isolated from the rest of the world, you can be certain that markets will decline. And it shouldn't come as a surprise. After all, long-term stock returns would be considerably lower if not for the opportunity to deploy more capital when the markets are down.

After the fact, these market downturns will seem to have been predictable. In addition, your investment horizon will become shorter. Bear markets cause panic and uncertainty. During these periods, investors tend to worry more about what their investments will be worth in the next hour than their value in 20 years. Being a long-term investor becomes particularly challenging in a market downturn.

Bear markets are the ultimate test of an investor's risk tolerance. And their consequences have more to do with investor behaviour than with the markets themselves. It all comes down to investment decisions!

All investors say they have a good investment plan—until they hit their first bear market. The key is to be disciplined and stick to the plan.

Asset allocation

EQUITIES | SLIGHTLY OVERWEIGHT
(55% VS. BENCHMARK 50%)

Over the second quarter, we performed several transactions to rebalance our portfolios and invest in markets that have seen a sharp drop. Until just recently our weighting had been neutral. Now it is slightly overweight. These rebalancing transactions will be particularly beneficial when the markets rebound. We added to our US position through QQQ (NASDAQ) and IVV (S&P 500).

In the United States, 2022 had a challenging start as real GDP decreased in the first quarter. We anticipate a return to growth in the second quarter. Subsequent real GDP gains will be slower as the economy contends with the effects of inflation and higher interest rates on household income.

The Bank of Canada is expected to continue aggressively tightening its monetary policy until the fall in order to rein in high inflation, which is already having a major impact on the housing market. Fortunately, this adjustment is taking place at a time when the Canadian labour market is strong, and household, corporate and government finances are in good shape. This should help mitigate the risk of a recession in the near term.

Fixed income | Underweight

(35% VS. BENCHMARK 50%)

Canada's bond market recorded its worst streak since the 1980s. At mid-year, the FTSE Canada Universe Bond Index was down by approximately 14%. Rising inflation and the potential de-anchoring of long-term inflationary expectations have driven several major central banks, including the Bank of Canada, to raise their key rates since March.

From a low of 0.25%, the Bank of Canada raised its benchmark interest rate to 1.50% in early June. It now anticipates that the rate will rise to as much as 3.50% by the end of this year. This figure is significantly higher than Desjardins Group's outlook of 2.25%. Household debt, inflation and the cost of money could make Canadians feel the pressure around the 2.25% mark, or even tip the economy prematurely into recession if the central bank slams too hard on the monetary policy brakes.

The silver lining of higher interest rates is that proceeds from interest payments and maturing bonds can finally be reinvested at much higher rates than had been available over the past 10 years.

From a tactical perspective, current inflationary expectations and monetary policy trends call for a cautious bond strategy (underweight on bonds in asset allocation, corporate securities and duration).

The average duration of our fixed-income component is currently 2.5 years versus 4.8 years for the benchmark index. Our strategy is to stay underweight on bonds versus the benchmark, but also to gradually increase our portfolio duration from mid-July onward after the Bank of Canada holds its next policy meeting.

Conclusion

While recent years have given us a fair share of surprises, rarely have the macroeconomic and financial environments been so uncertain as they are today. That makes the task of predicting the markets even more unpredictable! These uncertain times call for a well balanced investment strategy that avoids putting all your eggs in one basket. When in doubt, a balanced position should always prevail.

Today's market volatility should remind investors to think about some fundamental aspects of investing, like: (1) why they invest, (2) what they can and can't control, (3) controlling their emotions, (4) having realistic expectations and (5) the fact that it's okay to ask for help. On the last point, it's important to remember that expert advice can be extremely valuable in periods of volatility.

We hope that this information helps you better understand the markets. Please don't hesitate to contact us if you'd like to discuss our investment strategies in more detail. We'd like to reiterate our commitment to keep working hard to help you meet your long-term financial goals by seizing the best opportunities offered on the markets.