The first half of 2022 has been turbulent, to say the least.
The year began with renewed concerns about the pandemic. Thankfully, the omicron variant proved less severe than its predecessors, and our earlier optimism was restored.
While society appeared to be getting back on its feet, the highest inflation in decades emerged. This led to uncertainty as economists, financial advisors and investors tried to predict the impact of the central bank’s recalibration of policy in response to inflation that was proving to be less transient than originally expected. The result was spiking yields amid fear that strong medicine was required to tame inflation, which infiltrated the investor psyche.
If that wasn’t enough, Russia invaded Ukraine in February, spurring a major geopolitical event that caused another recalibration of earlier assumptions. The importance of Russia’s fossil fuels to Europe and the economic sanctions that ensued against Russia sent price shocks throughout the world for oil, natural gas and coal. Agricultural commodities have also been impacted due to Ukraine’s significant production of these products, contributing to higher global food prices.
While global capital markets have weakened because of the instability, commodities provided a safe haven for investors and should continue on this trend in the second half of the year, acting as an effective hedge to soaring inflation expectations. Strong demand and tight supply conditions from a decade of underinvestment in future production, as well as pandemic lockdowns and redirection of capital in favour of higher dividends and share buybacks, have strengthened the commodity complex.
However, advisors should note that if demand is destroyed by an economic slowdown or supply is enhanced through large capital inflows, the commodity cycle will not be immune.
With its commodity-driven economy, Canada stands to continue to benefit from the economic recalibration in the second half of the year and is one of the few markets that has experienced upward revisions in its outlook for growth and earnings expectations for S&P/TSX Composite–listed companies.
While it’s been a rough start to the year, the North American consumer continues to be bolstered by a healthy balance sheet, strong labour market and rising wages.
There has been mounting pressure on bond yields year-to-date — more than predicted — and equities will continue to struggle with the headwinds of inflation and tighter monetary policy in 2022. North America is expected to avoid recession this year, but there are signs there will be lower economic growth.
There is increased concern about the potential for recession in Europe due to the macroeconomic impacts of Russia’s invasion of Ukraine. Canada’s relative insulation, a stronger commodity backdrop, low unemployment and an increase in wages point to the best relative performance to occur in Canadian equities.
China, being the second-largest economy in the world, is an important consideration for the global economic outlook. As China’s “dynamic zero-Covid policy” has resulted in more lockdowns in economic hubs, ripple effects are being felt in already strained global supply chains, which link China to many of the world’s economies. Achieving the country’s lofty growth target of 5.5% for 2023 will require substantial monetary and fiscal policy support. Covid policies pose a challenging economic climate, and a misstep by the country could reverberate globally over the next six to 12 months.
As for the bond market outlook, uncertainty remains, but the focus away from a rates shock could quickly be replaced by fears of a growth shock if weakening economic data surface. This scenario will, at a minimum, provide support for bonds and potentially equities if markets view that the current tightening cycle is fully priced in.
While there are short-term tactical opportunities in this environment, the best approach for your clients, as always, will be diversification across asset classes and a long-term time horizon for riskier assets to ride out any short-term turbulence.
Lesley Marks is chief investment officer of equities with Mackenzie Investments.