indicatorFund Commentary

Sub Advisor Insights—Markets Q3 2022

Compass™ sub-advisors discuss the market and analyze the events during the third quarter of 2022.

By ATB Investment Management 3 November 2022 5 min read

Cardinal Capital Management Inc.

Contributed by: Cardinal Capital Management Inc.

Investors endured a roller coaster ride in the third quarter. After a sharp rise (from the June low) in the first half of the quarter, the financial markets retraced its summer gains and accelerated downward. With global inflation numbers remaining persistently higher than expected and monetary tightening carried out by central banks, investor nervousness increased.

The central banks’ unwavering resolve to combat inflation brought into question the health of the economy. Global slowdown worries and the spiking U.S. dollar sent crude oil prices lower for four consecutive months and into a bear market. The yield curve flattened and inverted signaling a possible recession on the horizon.

By the end of the quarter, market returns sunk into negative territory. All major global markets experienced losses in the quarter. While the S&P/TSX outperformed its peers, the index edged lower by 1.41%. The Industrial and Consumer Discretionary sectors led on the upside, but this was offset by weakness in the Energy, Real Estate and Communication sectors.

Canso Investment Counsel Ltd.

Contributed by: Canso Investment Counsel Ltd.

Any hope of a pause in monetary tightening by the Federal Reserve faded during the third quarter of 2022. Stocks and bonds tumbled toward the end of the quarter when the Fed Chairman vowed to fight inflation even at the expense of economic growth. The yield on the ten-year U.S. Treasury note climbed above 4% for the first time in more than a decade, while the dollar strengthened against other currencies to a decade high. The persistence of inflation and the moves by central banks around the world to lift rates have slammed markets. Meanwhile, Russiaʼs war in Ukraine and Chinaʼs COVID-19 lockdowns have further weakened the global economy.

It takes time for the full effects of higher interest rates to filter through the economy, leaving investors wondering how the sequence of rate increases will eventually affect the behaviour of businesses and consumers. Given the pace of monetary tightening, many suspect that an economic slowdown will dent corporate earnings and erode the attractiveness of company bonds and shares.

Debt markets are under stress. An investment strategy used by UK pension funds to protect themselves from falling yields in the government bond market has been blamed for backfiring when they surged instead. Funds following Liability Driven Investment strategies were forced to post more collateral on their derivative positions when prices for UK sovereign gilts collapsed suddenly, driven largely by their own selling. That prompted the Bank of England to step in to prevent a death spiral and a systemic crash. Wild swings were also felt in the bond markets after a UK government tax cut plan.

Cidel Asset Management Inc.

Contributed by: Cidel Asset Management Inc.

The Canadian equity market was relatively flat in the third quarter of 2022 declining a modest 1.4%. There was, however, a significant amount of intra-quarter variability with the TSX Index rising close to 11% from the July low to the mid August high before giving back the gains in late September. Driving the ‘see-sawing’ of the market between hope and fear appears to be changing opinions on the outlook for inflation and the expected interest rate moves by central bankers. In Canada, CPI did moderate slightly from the June high, but the Bank of Canada continues to raise short-term rates. According to Tim Macklem (Governor of the Bank of Canada), “Inflation in Canada has come down a little, but it remains far too high”.1 The Bank of Canada is attempting to raise interest rates just enough to tame inflation but not cause a recession, the so-called “soft landing”. However, as of the end of September, investors are not yet ready to compare Mr. Macklem with Captain Chesley “Sully” Sullenberger, from the Miracle on the Hudson.

Sector performance was mixed with eight sectors posting negative performance and four posting positive performance. The best performing sector was Industrials (+4.2%) followed closely by Consumer Discretionary (+4.2%). Consumer Staples (+2.6%) rounded out the top three. In general terms, stocks in these sectors that performed well were either weak performers heading into the quarter (Transforce, Boyd Group, Restaurant Brands) or were higher quality businesses with pricing power (Waste Connections, Dollarama, Couche-Tard). The first group benefited from a potential inflection point in inflationary pressures on margins, while the later group proved their resiliency in a high inflationary environment.

The bottom performing sectors were Communications Services (-7.5%), Real Estate (-6.4%) and Health Care (-6.4%) and Energy (-5.3%). The weakness in Communications Services was in part due to the weakness in both Rogers and Shaw as uncertainty remains about Roger’s take-over of Shaw. The weak Real Estate sector performance was due to ongoing multiple contraction as long-term interest rates started to rise again from the end of July. Health care was lower due to the weak performance of Seniors Housing and Bausch Health. Weakness in WTI oil (down 25% during the quarter) resulted in weakness in the Energy sector. There was some strength in the Energy sector with natural gas weighted producers performing well as NYMEX natural gas prices rose 25% during the quarter.

The negative 1.4% total return on the S&P/TSX for the third quarter was due to a slight contraction of the forward price-to-earnings multiple (which remains about 11.6x) combined with a modest rise in forward earnings. Given the ten year low in the forward price-to-earnings multiple, investors remain skeptical about the sustainability of forward earnings estimates.

Mawer Investment Management Ltd.

Contributed by: Mawer Investment Management Ltd.

Investors looking for a volatility breather in Q3 were disappointed as equity markets continued their bruising run in 2022. Despite some optimism early in the summer that led to a brief rally, most asset classes resumed their downtrends as the U.S. Federal Reserve and an increasing number of influential central banks have been unequivocal in their commitment to fighting inflation, which has increased the probability of a global recession. 10-year U.S. Treasury yields approached 4%, credit spreads widened, while the British pound, euro, and Japanese yen weakened precipitously relative to the U.S. dollar.

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