The first quarter of 2022 was marked by significant volatility. There were several causes, each adding to the next. The quarter was also, to some extent, split into two parts.

In late February, despite ongoing geopolitical tensions,the unthinkable happens: Russia invades Ukraine. The human toll is catastrophic and the shock and uncertainty of the invasion impacted financial markets, while having other financial implications. Russia’s direct economic and market presence is relatively limited. For example, prior to the invasion, the country’s weight in the MSCI Emerging Markets Index was just over 3%. By the end of the quarter, MSCI had decided to totally remove Russia from the index. Russia’s presence is felt most in its exports of several commodities, particularly oil, gas, wheat, and various metals. Following the invasion, the prices of these commodities spiked. The ramifications of higher prices led to strong returns from underlying Energy and Materials sectors. Gold, a traditional safe heaven for investors, also rose during the period.

In the following sections, we will discuss the impact of these events on the various asset classes and regions, and what to consider in the months to come as long-term investors.

Both the Bank of Canada (BoC) and the Fed increased their overnight rate to 0.50% during the quarter, their first hikes since 2018. While this was widely expected, language from Fed Chairman Powell became increasingly hawkish over the quarter, i.e., willing to increase rates, as the ability to easily rein-in or control inflation is clearly a challenge. This may also translate into potentially larger rate hikes in the future, such as increments in the range of 0.25% to 0.5% as opposed to 0.25%. For the month of February, 12-month inflation was 7.1% in the United States.

In Canada, the tone from BoC governor, Tiff Macklem was less aggressive. The intention is to continue with rate hikes in 0.25% increments as the need for more urgent action is not as apparent. Inflation does remain a big concern but relatively less than in the United States given lower absolute levels. The latest inflation result was 5.7% year-over-year for February in Canada.

The result was that global bond yields shifted broadly higher during the quarter, despite a quick flight to safety on February 24th and a slight decline in yields at the time, following Russia’s invasion of Ukraine. As a result, fixed income markets generated negative returns for the quarter, with the FTSE Canada Univers Bond Index posting -7.0% over the quarter and -4.5% for 1-year.

By the end of March, the U.S. bond market was reflecting 8 expected rate hikes this year compared to 3 at the end of 2021. In Canada, it was 8, compared to 5 at the end of last year. Central banks’ ability to control inflation is the main priority now. As subsequent rate hikes are implemented, the focus may shift towards economic growth, which is currently still healthy in North America.

Globally, we may see a divergence in monetary policy between North American and European and Asian countries, as they are facing a slightly different set of challenges as a result of the Russian invasion and Covid-19 policies.

Investing in bonds holds little appeal for investors at the moment. There are ways to mitigate some of these challenges such as through active duration and credit management. As long-term investors, we have seen the benefits of holding bonds through different market cycles and the insurance they provide. At the moment, the premium seems expensive, but has proven to be a longer-term worthwhile source of diversification and balance when appropriate.

As mentioned above, countries and stock markets highly exposed to commodities benefitted from the commodity rally. This was the case for Canada in particular, as the Energy and Materials sectors together represent over a quarter of the MSCI Canada Index. Financials stocks (almost 40% of this index) also performed relatively well, given that higher interest rates should benefit banks by providing higher net interest margins, and benefit insurance companies because of a lower current value of their future liabilities.

The Canadian dollar strengthened on the back of strong oil prices. COVID-19 restrictions also continued to be lifted across Canada, bringing some much-needed relief to the service industry, and restaurants in particular.

The MSCI Canada Index returned +3.6% for the quarter and +20.3% for 1-year ending March 31, 2022.

Canadian unemployment rate, while not at the same level as the United States, remains healthy. The main focus will continue to be the BoC’s rate moves and its ability to control inflation. It will be important to watch how rate hikes impact indebted Canadians, particularly mortgage holders, as well as the repercussions on a hot real estate market. As the supply of oil from OPEC increases, commodity prices should help balance returns.

The U.S. stock market correction during the quarter initially happened in response to the prospect of higher interest rates and to the impact that higher rates might have on the valuation and pricing of growth stocks typically found in the Information Technology sector, in particular. The sector represents almost 20% of the MSCI USA Index, and the correction can therefore be felt in the overall index return. As growth stocks suffered, value stocks, or companies that are viewed as having real assets “now”, benefitted, after years of relatively lower returns, demonstrating the importance of a well-balanced portfolio. Health Care and Consumer Staples held up well as investors fled riskier assets.

In local currency, the MSCI USA Index returned -5.2% over the quarter and +14.1% for 1-year ending March 31, 2022. In Canadian currency, the index returned -6.3% over the quarter and +13.4% over 1-year.

The U.S. index is up from its early March lows. With inflation levels at their highest since 1981, Americans are nonetheless worried, as demonstrated by the lowest confidence levels seen since August 2011 (per the University of Michigan Consumer Sentiment Index). That said, unemployment is at historical lows, and there is significant cash available, ready to deploy into a weak equity market.

Global markets began the year with a bit more uncertainty than their North American counterparts. Europe and the United Kingdom were struggling with their COVID-19 decisions and displayed continued uncertainty due to Brexit. Emerging markets were also grappling with their own set of problems, including low vaccination rates. China’s stock market rut, a result of its government-led regulatory overhaul, coupled with a zero-COVID stance weighed on overall Emerging Markets returns. The Russian invasion of Ukraine amplified the volatility and uncertainty worldwide and drove Emerging Markets returns even lower. Within this basket of countries, cyclical economies levered to commodities were clear winners.

In local currency, The MSCI Europe Index returned -5.2% over the quarter and +8.5% over 1-year. The MSCI Asia Pacific Index and MSCI Emerging Markets Index closed the quarter with a -3.9% and -6.1% return respectively. For 1- year, they returned -5.4% and -9.6% respectively.

In Canadian currency, The MSCI Europe Index returned -8.3% over the quarter and +3.5% over 1-year. The MSCI Asia Pacific Index and MSCI Emerging Markets Index closed the quarter with a -7.0% and -8.0% return respectively. For 1-year, they returned -9.8% and -11.6% respectively.

The global outlook is also mixed. Europe is looking for new sources of energy to avoid depending on Russia. This can mean investments in new partnerships and also new technologies and better sources of sustainable energy. It also means increased spending, which is expected to happen as several European countries have committed to increase defense spending too. For example, the German government announced 50 billion euros in military spending in its 2022 budget and set up an exceptional 100-billion euro fund. China continues to work through its various regulations and to deal with the arrival of Omicron.

There is no doubt that there are many risks to watch for. A prolonged war in Ukraine and the uncertainty surrounding the conflict and the actors involved will continue to weigh on equity markets. After two years of a pandemic and the latest possibly less-lethal, more virulent variant, there is discussion of yet another variant and an awareness that things can change quickly. China’s lockdown policies and whether they further exacerbate supply chain challenges will be monitored. This is also the case for how China navigates Russia-U.S. relations, as one of the world’s biggest economies continues to evolve towards domestic dependence. Central banks are facing different challenges depending on the continent they call home and monetary policy may diverge as some face slower economic growth (Europe, China). In North America, the risk is the delicate balance between increasing rates to temper inflation without stifling growth.

Longer-term inflation expectations remain within the target 2-3% range, signalling that investors believe current inflation levels are still temporary.

The quarter set the tone for the year with many risks on the horizon and significant volatility. It can be difficult to maintain a long-term outlook when events and risks seem to change daily. It is for this specific reason that it is important to do so. The FÉRIQUE Funds are managed with a long-term perspective and are focused on companies that are not reliant on a specific outcome such as rate hikes, elections or another event. Our Fund managers integrate a variety of scenarios in their assessment of companies and build well-diversified funds able to grow over a variety of market cycles.

As always, we achieve our investment objectives by having an investment plan, reviewing it periodically with a professional and sticking to it.

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