Cardinal Capital Management Inc.

Contributed by: Cardinal Capital Management Inc.

The second quarter of 2022 was challenging for the markets. Inflation has remained persistently high and central banks have become even more hawkish leading to aggressive tightening policies. The interest rate yield curve has flattened leading to fears of a significant economic slowdown and a global recession. In addition, the ongoing conflict in Ukraine and the slowdown in the Chinese economy due to strict covid measures has undermined investor sentiment. 

Global equity markets saw a sharp pullback in June, leading many indices to be near or in bear markets. In North America, U.S. stocks entered bear market territory in June while Canadian equities fared better. Canada’s high exposure to the natural resource sector helped to limit the losses. 

In Canada, the economy unexpectedly slowed in May despite holding up reasonably well in prior months. This has raised fears that it is slowing sooner than anticipated. With inflation running at 39-year highs, the central bank is expected to continue to raise rates aggressively, even if it results in slowing economic growth. Financial markets will continue to be volatile as central banks battle inflation. 

Despite the volatility in the second quarter, the portfolio held up well against the benchmark. The portfolio returned -8.79% in the second quarter resulting in relative outperformance of 440 basis points against the benchmark return (S&P/TSX Composite Index) of -13.19%. Outperformance in the first quarter and second quarter of this year has increased the value added against the benchmark for the one year, two year and since inception performance numbers.

Canso Investment Counsel Ltd.

Contributed by: Canso Investment Counsel Ltd.

Accelerating inflation and rising interest rates caused the global markets to take a bruising in the first half of the year, the worst in several decades. Stocks, bonds, emerging markets and cryptocurrencies all posted steep losses. One of the few assets that rose in the first half was certain commodity prices. Oil and gas prices rose after the Russia-Ukraine war disrupted imports from Russia, the third-largest oil producer in the world. Investors seeking refuge from volatile financial markets have also piled into the U.S. dollar as a safe bet. The currency at a multi-decade high is also getting support from the Federal Reserveʼs aggressive interest rate increases.

The Fed admitted that inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices and broader price pressures. They have raised interest rates three times this year. The most recent increase was by 0.75% in June, which was the biggest such move since 1994. The central bank is also starting to reduce its holdings of Treasury securities, agency debt and mortgage-backed securities. Investors concede that the current economic environment in which inflation is high, borrowing costs are rising and growth is expected to slow, makes it difficult to be enthusiastic about many parts of the market.

The Bank of Canada increased their overnight rate to 1.5%. Economic growth is strong in Canada and household spending has strengthened after the lifting of public health restrictions. Housing market activity has moderated from its lofty levels. Job vacancies are elevated, and companies are reporting widespread labour shortages. Wage growth has picked up across sectors. The Bank of Canada is concerned about the risk of elevated inflation becoming entrenched and has guided to further rate hikes to curb inflation.

Cidel Asset Management Inc.

Contributed by: Cidel Asset Management Inc.

The Canadian equity market was weak in the second quarter of 2022 declining 13.2%. The ongoing headwinds of inflation and tightening monetary policy resulted in negative returns in all sectors of the Canadian market. 

From a sector performance perspective, the sectors that declined the least were Energy (-2%), Utilities (-3.5%) and Consumer Staples (-6%). The ongoing war in Ukraine continued to drive a geopolitical premium in global oil prices due to concerns over oil supply. Oil prices rose 5.5% (West Texas) in the second quarter and are now up 41% in the first half of 2022. While there was significant variation of equity performance within the Energy sector, the integrated oil and gas producers were the best performing of the group up 11%. Exceptionally strong refining margins propelled these equities higher. Given the above noted headwinds of inflation and tightening monetary policy and now fears of a recession, it was not surprising that the defensive sectors, Utilites and Consumer Staples, performed relatively better than the broad market. 

As investor concerns increased, selling pressure was most acute in the following three sectors: Healthcare (-50%), Information Technology (-31%) and Materials (-24%). Within the Information Technology sector, Shopify was down a further 52%. The sector continues to suffer from revaluation as the sharp rise in long-term interest rates continued during the quarter with the yield on the Government of Canada 10-year bonds rising another 82 basis points. Rising interest rates clearly have a material negative effect on the discounted value of the cash flow of a company whose cash flows are further out in the future. The lower price of copper (down 20%) and the lower price of gold (down 7%) were the primary drivers of the weak performance of the materials sectors. The copper price was lower on recession fears, while gold prices were lower due to rising real interest rates due to continued evidence of inflation. 

The negative 13.2% total return on the S&P/TSX for the second quarter was due to the contraction of the forward price-to-earnings multiple from about 14.1x to 11.6x despite forward earnings rising 6% during the quarter. Clearly investors remain skeptical about the sustainability earnings estimates.

Mawer Investment Management Ltd.

Contributed by: Mawer Investment Management Ltd.

Investors have had a punishing year so far in 2022 … and in the second quarter there were even fewer places to hide. Ever-higher measures of inflation have emboldened influential central banks (such as the U.S. Federal Reserve) to take a tougher stance against inflation. Despite a reversal toward the end of the quarter, bond yields moved higher in most major economies. 

The level of inflation and the degree of central bank intervention needed to rein it in have given way to concerns about economic growth, exacerbated by a cornucopia of shocks such as war in Ukraine, COVID-19 lockdowns in China, as well as the impact of rising food and energy prices on consumers. In a sign of the degree of investor anxiety, both the euro and the Japanese yen have slid to multi-decade lows relative to the U.S. dollar. The combination of higher discount rates and a more muted outlook with respect to companies’ top-line growth and margins have added further fuel to the sell-off.