Julian Hoyle
May 24, 2022
Economy Commentary Quarterly commentaryThe Fog of War
The end of 2021 proved to be a tough act to follow. After a solid recovery in economic activity and robust corporate earnings, North American equity markets had a choppy start to the year. Despite promising results reported by most companies in January, surging inflation, supply chain bottlenecks, labour shortages, and soaring energy and commodity prices began to influence investor sentiment. The Russian invasion of Ukraine stunned the world and caused many economic shocks to reverberate through the market. Supply disruptions in oil, gas, fertilizer, uranium and steel caused commodity prices to spike. Inflation, which was already rearing its head, started to rise in a dramatic fashion.
At the end of March, Canada’s S&P/TSX Composite Index posted a total return of 3.5% year to date, with the energy and materials sectors outperforming. Energy stocks gained 28.8% during the quarter, as the impact of already tight supplies of crude oil were exacerbated by economic sanctions imposed on Russian oil exports by the West in response to the conflict. Natural gas prices, which were also moving higher due to tight supply in the face of increasing demand, continued their upward trend. In March, the Consumer Price Index rose by 5.7% year over year, a number much higher than the government of Canada’s target 2%. This would lead to action.
At the same time, a rally in the technology and communications sector that had been ongoing since the early days of the pandemic, came to an abrupt end. The S&P 500 Index posted a total return of -4.9% for the quarter, largely influenced by the sharp technology sell off. The Dow Jones Industrial Average and the technology-heavy NASDAQ Composite Index fell 4.3% and 9.5%, respectively.
For the last decade (and more) we have been in an era of low interest rates and accommodative monetary policy. This was set by central banks to recover from the economic issues of the late 2000s. Strong results (both in the markets and through GDP numbers) over the last two years, coupled with the inflation discussed above, have sparked central bankers to take the opposite approach, and begin more restrictive policy. This is traditional Keynesian economics (at least partly), and is to be fully expected given the results we are seeing. The Bank of Canada raised the overnight interest rate by 25 basis points (bps) to 0.50% on March 2, marking its first rate hike since October 2018. They have since raised rates by a further 50 bps and will likely continue to do so throughout the year.
What we are seeing is just another stage in the economic cycle. Though the players may be different, the mechanics and many of the impacts have all been seen before. We do believe the North American economy has strength and can still grow. We know that owning companies with stable dividends and strong balance sheets will help weather these rather large disruptions. Further, we feel that if oil prices sustain their level at multi year highs, the Canadian economy can benefit.