Interest rate increases, coupled with elevated inflation and recessionary fears, have led to another volatile quarter for investors. On top of a challenging first quarter, many markets, particularly the bond market and US equity market, experienced first-half declines not seen in several decades.

As interest rates continued to rise over the quarter, bond prices fell, leading the broader bond market to a -5.7% return and a -12.2% return through the first six months (bond prices work inversely to interest rates). This represents the worst six-month period since at least 1980. The silver lining is that  bond yields are now the highest they have been since 2008 — any bond held or newly purchased will now return about 2% more per year until maturity compared to yields at the end of 2021. Read more about that in our recent article on bonds. 

During the quarter, global equities fell in lockstep as Canadian, US, and international equity markets all experienced declines of roughly 12% to 13.5% in Canadian dollar terms. This is despite earnings growth remaining positive. Year-to-date returns on Canadian, US, and international equities in Canadian dollars were -10%, -19%, and -18% respectively. During the quarter, the US stock market officially entered bear market territory having fallen 24% from its all-time high in early January. 

As the chart below shows, investors should take heart. Periods of poor market performance have generally been followed by periods of exceptional returns.

Interest rates:

In the Bank of Canada’s (BoC) ongoing fight to rein in inflation, on July 13 (technically the third quarter) the BoC raised its benchmark interest rate by a surprising 1%. This was on top of a 0.50% hike during the second quarter. After starting the year at 0.25%, total interest rate hikes of 2.25% have the benchmark rate now sitting at 2.5%. After this latest hike, the big five banks along with ATB were quick to raise their prime lending rate which, at 4.7%, is the highest since September 2008.

Inflation:

The most recent inflation reading in Alberta and Canada respectively showed an increase of 8.4% and 8.1% year over year, the highest reading since 1983 (also the first year the Oilers met the Flames in the playoffs). 

Oil prices:

Oil prices spiked immediately after the invasion of Ukraine by Russia in the first quarter. This has been partly responsible for the elevated inflation readings the global economy has experienced this year. That said, the price of a barrel of oil (as measured by WTI or West Texas Intermediate) fell during the last month of the quarter. After trading at over $120/barrel as recently as June 7, it ended the quarter around $106. At the time of this writing, oil had fallen to below $95 per barrel.

Supply chains improve

Through the pandemic, supply chain backlogs became a regular headline. The good news is that supply chain pressures appear to be easing. The New York Fed’s aggregate supply chain measure now shows a material improvement (see next chart). Similarly, US manufacturers are now complaining much less about supplier deliveries.

Unemployment:

The unemployment picture remained very healthy this past quarter as both the Canadian and US unemployment rates remained near historically low levels. At the end of the quarter, the unemployment rate in Canada was 4.9% whereas the US unemployment rate stood at 3.6% (just above its all-time low of 3.5%).

The Compass Portfolios and ATBIS Pools (the funds) were down in absolute terms for the quarter along with the broader markets, but outperformed on a relative basis across both fixed income and equities. Read the full ATBIM Portfolio Managers’ commentary for the second quarter.

Sticking to your long-term investment strategy

A conscious and thoughtful decision to do nothing is still a form of action. Have your financial goals changed? If your portfolio is built around your long-term goals, a short-term change in markets shouldn't matter. Having a written Investment Policy Statement (IPS), has been shown to help investors stick to their long-term plan.

Risk tolerance

Investors can often overestimate their willingness to take on risk during periods of calm or exuberant markets. It can be during periods of falling markets when one’s true risk tolerance will reveal itself. Taking on appropriate levels of risk (bond to equity ratio) in advance will help you to ride out these periods of volatility without sacrificing your long-term returns, and protect your portfolio from permanent loss.

Portfolio construction

A diversified portfolio benefits investors in a number of ways:

• Eliminating the risk of a permanent loss of capital
• Lowering overall portfolio volatility as asset classes, sectors, and individual countries typically run on different return cycles
• Helping investors to not chase performance

Despite both the Canadian and US stock markets reaching all-time highs earlier this year, recent market declines have investors concerned about what lies ahead. The takeaway an investor should have at times like this is that every crisis, real or perceived, be it economic, geopolitical, or market related, has eventually been overcome and markets move onto new highs.

Best-selling author Jeremy Siegel, who has tracked the US stock market’s performance over a couple of centuries, shows that equities, which ultimately represent an ownership in businesses, have produced returns higher than any other asset class over the long term. It is the only asset class to take advantage of human ingenuity and society’s ongoing drive for improvement.  Siegel acknowledges, however, that despite the historical evidence, it is likely to be our emotions that will drive our investment behaviour, and that successful investing is far more about being able to resist our very human (and normal) impulses of fear.  

In his best-selling book, The Psychology of Money, Morgan Housel writes “I am a passive investor optimistic in the world’s ability to generate economic growth and I’m confident that over the next 30 years that growth will accrue to my investments.”

As historical evidence firmly bears this out, he might be onto something.