Global inflation was the economic story of the year

Inflation coloured every aspect of the global economy in 2022 and will continue to play a significant role in 2023, even as it diminishes, says Justin Truong, senior manager, investment strategy, with Mackenzie Investments.

Truong said falling supply-side demand and shipping costs, faster delivery times and rising inventory levels all suggest that inflation has peaked. But its retreat next year is likely to be slow.

“Inflation will remain structurally higher than many people expect,” he said on the latest episode of the Soundbites podcast.

Truong, who is based in Toronto, said North American economies are arguably still feeling the effects of the easy fiscal and monetary policy of 2020 and 2021. But as we move into 2023, economic conditions will more closely reflect the tighter policies of 2022.

“It’s really important for investors to remember that fiscal and monetary policy historically comes with a one- to two-year lag before it begins affecting the real economy,” he said.

He expects markets to continue to deal with factors that contribute to tighter markets: higher bond yields, widening credit spreads, a surging U.S. dollar and lower equity prices.

“If I had to characterize 2022 with one word, it would certainly be ‘tight.’ That’s virtually been the only story that has mattered for markets this year,” he said, adding that investors can expect more choppiness in markets, and more modest returns as economic conditions continue to shift away from an environment of low inflation and loose financial conditions.

“The title I’m using for many of my market outlook presentations as we wrap up 2022 and move into 2023 is ‘Investing in the post-Goldilocks era,’” he said. “Rates are no longer pinned to zero, and investors will need to be more selective in their investments.”

Among other assets, Truong is looking at bonds.

“With U.S. Treasury bonds yielding 3.5% to 4%, and more in the investment-grade and high-yield space, we’re finally receiving a more attractive income proposition from our bond investments, which has not in the case prior to this year,” he said. “We may actually see some price appreciation in our fixed-income investments as central bankers pivot their attention from addressing inflation to supporting growth. And they’ll do so by perhaps cutting rates.”

Truong said 2023 will allow 60/40 portfolios to shine again, with the diversification benefits of bonds becoming apparent as an economic downturn takes hold.

“If my view turns out to be correct, we will see the Fed hike rates up to a terminal rate of 5% to 5.25%, followed by a pause,” he said. “And that pause will take place until an economic slowdown materializes, which will then prompt the Fed to cut interest rates to support economic growth.”

He said the big winners of 2022 have been energy stocks, which have seen ballooning profits. Some S&P 500 energy companies saw increases in earnings of over 130% as of the end of Q3 of this year.

“On the flip side, this year’s biggest loser has been these new-economy tech stocks that we saw benefit greatly from the early parts of the pandemic.”

As interest rates rose, we saw a contraction of stock valuation multiples.

“Because many of these companies are unprofitable, with their future cash flows expected further out on the timeline, that makes them most sensitive to interest rates,” Truong said. “And as result they’ve suffered the most this year.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.