Canadian equities will likely remain the safest place for investors in the second half of 2022, with natural resources providing a hedge against inflation, a report from National Bank says.
The S&P/TSX Composite index was a relatively strong performer in a brutal six months for investors. The maximum one-year drawdown for Canadian equities was 14.8% as of July 7, compared to 32% for the Nasdaq and 23.4% for the MSCI Europe index, the report said. The FTSE Canada Universe Bond index is down by more than 12% for the year.
“The important question now is where do we go from here, and what kind of investments should one consider for the different possible market environments of the future?” the report asked.
The authors examined base case, bullish and bearish scenarios and mapped “post-pandemic survival strategies” and Canadian ETFs onto each.
Under the base-case “flirtation with stagflation” scenario, the authors recommended Canadian equities. Central bankers will continue to struggle with inflation under this scenario and growth will slow, but a recession is avoided.
Stock market performance from the 1970s and 1980s shows that Canadian stocks outperform U.S. equities during periods of stagflation, the report said.
“This follows sensibly from the fact that our equity market has lower valuations with high exposure to natural resources, making it a natural inflation hedge,” it said.
On a sector basis, products that invest in energy, gold, miners and industrials tend to outperform in this environment, it said. Factor products focused on U.S. quality and U.S. dividends were also recommended.
With volatility likely to remain high, the report said market-neutral strategies could also continue to outperform markets.
Bearish scenario: Recession
If the U.S. Federal Reserve doesn’t manage to slow inflation and lower its rate hike intentions by the end of this year, monetary policy would likely move into restrictive territory and trigger a recession, the report said.
In such a scenario, investors may want to look at strategies that performed well during the brief bear market at the onset of the pandemic in March 2020. These strategies included low volatility, market neutral, gold, long-term government bonds, the U.S. dollar and one-stop conservative portfolios, the report said.
Within equities, sectors such as consumer staples and utilities would likely be safer.
Bullish scenario: Pro-growth
This is the least likely scenario, with the authors calling a growth slow-down “inevitable.”
Optimistic investors who believe the sell-off was overdone or that a pro-growth environment is about to return have options, though. Hard-hit tech stocks in the U.S. and Canada could provide the biggest bounce-back, the report said. Emerging market bonds could also recover if the U.S. dollar’s primacy is challenged.