What makes the market’s wild ride this year especially unique is just how broad the selloff has been for both equities and bonds alike, and we don’t expect this to change much until central bankers are done tightening, or when pundits start to see that markets can indeed thrive in a high-rate environment.
Yes, top-line inflation is coming down, thanks to falling gasoline prices as we saw in the United States two weeks ago and Canada last week, but certain components within the consumer price index (CPI) remain a problem that do not appear to be going away as fast as bankers would like — at least not yet anyway.
For example, the cost of groceries in the past year has risen by 10.8 per cent, the fastest increase since 1981. And core CPI, a key benchmark central bankers watch because it measures the typical person’s cost of living, hasn’t reacted much to the flurry of rate hikes so far.
The core CPI rate in Canada decreased to 5.8 per cent in August 2022, down from 6.1 per cent in July, but ahead of the expected 5.7 per cent and still close to its June high of 6.2 per cent.
Core CPI in the U.S. is even worse, accelerating to 6.3 per cent in August of 2022, the highest since March, from 5.9 per cent the previous month and above market forecasts of 6.1 per cent.
The magnitude and pace of rate hikes will likely continue until central banks change their ways in order to prevent an acceleration in wage increases. This is because employees now have incredible pricing power given the record number of the job vacancies: one million in Canada and 11.2 million in the U.S.
Unless these job openings normalize, or the price of consumer goods fall, it will just be a matter of time before employees demand significant raises to compensate for the huge cost-of-living increases they’ve been experiencing.
As a result, we don’t think duration risk is going away any time soon. It should still be kept to a minimum and not bet on when it comes to managing the sensitivity of your portfolio to rate hikes.
We, for example, still have the lowest weighting to fixed income allowed within our mandates, still hold a lot of U.S. dollar-denominated assets and have a reasonable weighting to energy and commodities as an inflation hedge. We also have a near-zero weight to those regions impacted by the worsening energy crisis, such as the Europe, Australasia and Middle East markets.
“When you shame oil and gas investors, dismantle oil and coal-fired power plants, fail to diversify energy supplies (especially gas), oppose LNG receiving terminals, and reject nuclear power, your transition plan had better be right,” Saudi Arabian Oil Co. chief executive Amin Nasser said.
“Instead, as this crisis has shown, the plan was just a chain of sandcastles that waves of reality have washed away. And billions around the world now face the energy access and cost of living consequences that are likely to be severe and prolonged.”
But it might be worth dipping your toes in the U.S. and Canadian equity markets if you are underweight. We really like the S&P/TSX composite and think it will outperform given its energy weighting. But even the powerhouse U.S. equity market looks attractive, because after stripping out the mega-cap growth stocks, they are trading at near 12 times earnings, which is close to recessionary levels.
As mentioned in previous columns, we also have a large weighting to structured notes, which are an equity/fixed-income hybrid that have coupons dependent on indexes such the S&P 500 or S&P/TSX composite. We like them in these flat-to-down, but volatile markets, because their attractive yields range from five per cent to as much as 20 per cent, and they also offer downside protection ranging from 25 per cent to 40 per cent.
The bottom line is that investors need to do more than simply “wait it out” or, worse, “betting on” central bankers to slow their tightening. Understanding the nature of the current environment and adapting your asset allocation accordingly can go a long way to help manage the macro risks that are creating an overhang on the markets that just doesn’t seem to be going away any time soon.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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