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After starting the month strongly, equity markets in North America ended up giving back those gains in the last week of August to end flat to slightly down. Comments from Fed Chairman Jerome Powell about interest rates having to be higher for longer to combat inflation prompted the late month sell-off.
North American central banks continued their tightening cycle in July leading to higher short term interest rates. The Bank of Canada caught the market off guard, raising it’s target overnight rate by a full percent, while in the US, the Federal Reserve increased it’s fed funds rate by 0.75%. Both banks are trying to reign in surging inflation numbers in their respective country. Despite these increases to interest rates by the central banks, longer term bonds rallied (meaning their prices rose), leading to a monthly gain for the Canadian Bond Universe Index for the first time in 2022.
The S&P 500 falling into a bear market (down over 20%) has generated a number of worrisome headlines in the media. The leading causes for stock weakness remain the same and should not surprise market followers: stubbornly high inflation, rising interest rates and fears of a sharp
economic slowdown. It is worth noting that the S&P/TSX has held up far better than its US counterpart this year, given its relative higher exposure to Basic Materials and Energy which are traditional inflation hedges. Canadian stocks’ more attractive relative valuation has also helped cushion the blow.
After seeing significant losses in each of the first four months of the year, May saw markets end the month relatively flat, though not without significant price swings. Equities continued their slide early in May, declining over 5% in both Canada and the U.S., but ended a 7-week losing streak with a strong upward reversal later in the month. For the month of May the S&P/TSX was up marginally, gaining 0.06%, while the S&P 500 increased 0.18% in USD terms (though down 0.94% in Canadian dollars). Fixed income markets also found some footing during May as the CDN Bond Universe was down only 0.07%.
The shape of the interest rate yield curve has caused much concern of late. In the U.S., rates inverted briefly with the 2-year bond yield slightly higher than the 10-year bond yield for a moment. This closely followed relation has predicted each U.S. recession since 1969 – but has also incorrectly predicted many recessions as well. The situation should be monitored, but the silver lining is that the inversion this time was very brief and the signal tends to have a long lead time (12-18 months). If we are in a flat (or even inverted) yield curve environment, equity leadership will likely rotate into more defensive or less economically sensitive sectors. For the month of April, markets in Canada and the U.S. were off significantly, with the S&P 500 down about 6.5% in Canadian dollar terms, while the S&P/TSX was about 5% lower.
The central bank’s job is getting more complex with a geo-political conflict adding to an already challenging first quarter environment of high inflation, low unemployment, signs of slower economic growth and still high monetary stimulus. Perceptions stood that central banks were already late in starting to remove the stimulus and the persistent price pressures only confirmed the Bank of Canada (BoC) and the U.S. Federal Reserve (Fed) are behind the inflation curve and much work is needed.
As market focus shifts from a slowing pandemic, another more concentrated risk has appeared in the form of a Russian invasion of Ukraine. The result of the conflict on financial markets remains uncertain, however it clearly will have an impact on the devleoped world through higher energy and food prices. Between them, Russia and Ukraine are significant exporters of crude oil, natural gas and wheat.
After an extremely strong 2021, January presented investors with more volatile stock swings. No sector was harder hit than high multiple technology stocks as concerns about rising inflation and associated higher interest rates took center stage. Although Omicron continues to be in the headlines, it is not the primary market mover at this point and is the belief of many that COVID-19 will soon morph into something more akin to a bad flu (more infectious but less severe than it’s original iteration).
Despite a second calendar year of a global pandemic, in 2021 equity markets in North America - and many parts around the world - climbed to new all time highs. Expectations for a global economic recovery from a weak 2020, as well as continuted historically low interest rates helped fuel performance.