Just as central banks stood pat on Wednesday by not raising their policy rates, so too should advisors when it comes to their strategies for clients, market experts suggest.
To many people’s surprise, both the Bank of Canada and the Federal Reserve chose not to raise rates this week despite inflation levels not seen in more than three decades. The Bank of Canada decided to leave the target for its overnight rate at 0.25%, while the Federal Reserve held its target at 0% to 0.25%.
The decisions came after a volatile start to the year in equities markets, with the S&P 500 index down almost 9% for the year when markets closed on Wednesday, and the S&P/TSX Composite down almost 3%. The tech-heavy NASDAQ Composite index was down more than 12%. Markets were recovering some of those losses on Thursday.
Craig Basinger, chief market strategist at Purpose Investments, said 2021 had such little volatility that it couldn’t last.
“We certainly knew that 2022 was going to see some potential changes in trends, because we’ve got central banks that are going to tighten this year, quantitative easing is going away etc.,” he said.
Add the effect of inflation on investors’ psyches and there was bound to be some volatility, Basinger said. “I think it just accelerated pretty quickly at the beginning of this year.”
Despite the volatility, and in light of Wednesday’s central bank decisions, Basinger said advisor-client conversations don’t need to change.
“I would continue to focus on the fact that the U.S. equity market is probably one of the higher-risk markets at this point,” he said.
Large tech firms dominate market-cap weighted indexes such as the S&P 500, which Basinger said creates concentration risk. He said it’s time for a more defensive and value-tilted strategy, with broader diversification into Canada and international markets.
“If you believe inflation is going to pick up, to a certain degree, for longer than it has historically, and if you believe that we’re at the start of a tightening cycle, then there’s a very distinct chance that we’re starting to see potential leadership change away from growth and towards other areas of the market,” he said.
Lesley Marks, chief investment officer of equities at Mackenzie Investments, said the same factors spooking markets today — fears around inflation, monetary policy and Covid-19 variants — were present at the end of last year. Yet, markets were reaching new highs.
“We think what has changed is that the market is more concerned that the central bankers are behind the curve in being able to tame inflation,” she said. “In response to that, they’ll have to move more quickly to increase interest rates this year than was originally thought.”
Marks noted the omicron variant’s impact on the supply chain can’t be understated, something the Bank of Canada discussed in depth in its latest monetary policy report. As a result of the variant, the central bank is projecting “moderate” global growth this year of 3.6%, which would be a decrease from 6.8% in 2021. For the Canadian economy, the bank projects growth to be around 4% this year.
“On the margin, there has been some change that has created headwinds for the market today,” she said. “But we expect those headwinds to be temporary.”
In terms of investment strategy, Marks said the central banks’ announcements on Wednesday wouldn’t change anything. The expectation is that both central banks will raise rates at their next meetings in March.
The fact that the Bank of Canada noted the global economy’s strength, the rebound in oil prices, strong employment growth and a tight labour market created a bit of confusion and, potentially, market volatility over the next couple of months, she said.
“All of that narrative really came together to make you think that this was the time for them to increase interest rates,” she said. “To say, ‘We have all the pre-conditions to increase interest rates, but we’re not going to do it today,’ that’s a very confusing message.”
The omicron variant’s economic impact may have been the decisive factor in the decision to hold, she said.