indicatorPortfolio Managers' Commentary

Portfolio Managers' Commentary, Q3 2022

By ATB Investment Management Inc. 5 October 2022 5 min read


  • Despite a tumultuous quarter, bond and stock markets ended close to where they began on June 30.
  • The Compass Portfolios and ATBIS Pool funds (the funds) also saw relatively flat performance quarter over quarter ranging from 1.3% to -2%.
  • Yields continued to climb as central banks reiterated their commitment to lowering inflation. Bonds overall offer some of the highest yields since 2008, and it’s starting to make a difference in dampening negative returns even with rising rates. Canadian bond returns increased 0.5% despite yields rising 23 basis points overall.
  • US equities were up 1.86% in CAD terms,1 but lost just under 4.9% in USD terms thanks to the USD strengthening compared to all other currencies. Canadian markets lost 1.4%,2 and international markets fared worse, losing just over 2.8%3 in CAD terms, or 9.2% in USD terms.
  • Inflation remains elevated, but there are positive factors at play that may help including decreasing oil prices and improving supply chains.

Inflation hangs around

Based on how equity and fixed-income markets performed over from July to September, it was a relatively flat period for investment returns. And yet, that hides the reality of another volatile quarter, where markets staged a strong rally during the first half, then lost those gains during the second half.

Inflation, interest rates and energy continued to be the main themes in Q3 2022. In the US and Canada, the headline consumer price index (CPI) numbers, which had peaked in June, showed declines in both July and August. The moderation in general prices led the market to hope for a change in interest-rate policy, whether a signal that central banks would turn to cutting rates or even just pause increases.

Equity markets, as they had done earlier this year, appeared to run ahead of themselves with Canadian equities up almost 8%, and US equities up over 14% (CAD terms), by mid-August. But with inconsistencies in energy supply (in particular, Russian natural gas to Europe), and US Federal Reserve Chairman Jerome Powell stating that more needs to be done to tame inflation, markets turned negative and fell back to the lows experienced in June.

A steady fall in the price of oil (above US$120 in June to below US$80 in September) contributed to the fall in headline CPI. But Powell’s words reinforced how central banks focus on core inflation measures—which exclude energy and food—to set policy. Core measures have been slower to move the dial, but as higher interest rates dissuade consumers, and the economy shows signs of slowing (manufacturing, jobs), it’s expected that inflation will fall more rapidly.

Over time, staying invested in equities and corporate bonds can help weather the effects of higher inflation, with some companies being able to pass on the impact of inflation to consumers.

Staying the course in the funds

Over the quarter, the funds saw minimal changes within equities, which has been the case for all of 2022. Volatility remains high, and coupled with talks of recession, it might seem like the ideal time to change holdings, but the lower valuations found across sectors now compared to valuations last year continue to be relatively uniform. The fundamental impacts to revenue, profitability, and earnings that typically materialize during a recession—which can be a catalyst to make changes in the equity portfolio—by and large have not occured. In fact, revenue and earnings growth have persisted in 2022, and are still forecasted to grow in 2023.4

We partner with sub-advisors who invest for the long term in profitable, well-managed companies. From that point of view, seeing few changes from our sub-advisors in these turbulent markets underscores the conviction in our current holdings. Instead of significant changes to the companies we hold, the actions taken this year in the funds have centred around rebalancing when the opportunities present themselves due to volatility. That has primarily involved trimming Canadian equity and fixed income while adding US and international equities.

MSCI ACWI Index Forward Sector P/E Ratios

Sector valuations surprisingly uniform throughout the year despite volatility

Source: MSCI via Bloomberg

A recession with an earnings pullback over the next few years is possible, but so far it has not happened. Instead, it could be inferred that this year’s price declines across various assets including stocks are due to higher interest rates. As rates have risen, prices on investments decrease to reflect the now higher rate of return needed to compensate an investor. One such measure for stocks is earnings yield which for global stocks started the year at around 5%,5 and is now closer to 7% as a result of prices declining close to 20%. This aligns roughly with the 2% increase in yields witnessed in long-term bonds year-to-date.6 Based on metrics such as the earnings yield, forward-looking return expectations on equities today are materially higher than the end of 2021.

While the strategy for the equity portfolio remains “stay the course,” there have been meaningful changes within the fixed-income holdings. The quick pace of interest rate hikes by central banks this year has left investors with the highest government bond yields since 2008,7 now around 3.5%. While higher yields are welcome for savers, the central banks are doing this to slow demand. Historically, these periods following rate hikes have a higher probability to end with a recession. Recognizing the risks, the quality of the fixed income has improved throughout the year. Roughly 29% of each fund's fixed income holdings are now federally backed securities, up from 15% at the start of the year. Should business conditions worsen, and credit deteriorate, these highly liquid securities can be pivoted back into higher-yield fixed income if they present exceptional value to unitholders. In the meantime, the overall bond portfolio including mortgages as of the end of the quarter was priced to yield 5.6%. A common investment theme over the past decade has been the search for yield; it’s safe to say it has been found.

As alluded to earlier in the economic recap, this quarter saw large price movement but finished close to where it started. The funds’ performance from Compass Conservative to Maximum Growth ranged from -0.5% to -2%. The asset class pools show the same–both fixed income and regional equities overall saw little change from where we ended on June 30. Relative performance compared to broader indices8 for the most part was very close. Fixed income, Canadian equity, and US equity were all within 0.3% for the quarter. International equities had a larger differential outperforming the MSCI EAFE index by 1.3%. This difference stemmed mostly from better-performing financial and industrial stocks within the Mawer International holdings.

Compass Portfolios returns - Series A
Total returns

Source: ATBIM

ATBIS Pools returns - Series F1
Total returns

Source: ATBIM

Where we go from here

Investors are now nine months into a downturn for both stocks and bonds, and for some, the urge to make changes is strong. But as long-term investors, we are optimistic this bout of volatility will pass. In the meantime, we remain focused on underlying valuations, which look meaningfully more attractive than at the start of the year for both stocks and bonds. 

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