11 February, 2022

Weekly Update - Volatility as Inflation Marches Higher

Volatility is back as markets grapple with the trend in higher inflation, and cautious sentiment around how exactly central bank policy will respond. Both the U.S. Federal Reserve and The Bank of Canada have telegraphed an increase to interest rates in the coming months, however, until there is more concrete action, investors are left to their own devices to take positions. 

 

U.S. inflation for January was up 7.5% year over year, above forecast and reaching the highest level in 40 years. The Fed is seen by some economists as ‘behind the curve’ and in need of some action to catch up with inflation. This is fueling increased expectations of a more significant interest rate move in March than previously anticipated. 

 

Softening consumer sentiment, the viability of historically high stock valuations, and geopolitical uncertainty, particularly in Ukraine are also adding to the cautious tone.

 

The S&P/TSX has trended higher this week, at one point reaching an all-time high as rising bond yields and oil prices helped financials and energy names move higher. In the U.S., the S&P 500 and NASDAQ indexes were relatively volatile, but ultimately ended the week approximately flat. U.S. equity markets have been negative so far in 2022.

 

Bond yields have reacted by moving higher, with the U.S. 10-year Treasury cresting over 2.0% for the first time since late 2019. Interest rate sensitive tech stocks have moved up and down with shifting sentiment but have largely moved lower on the pressure of higher rates.   

 

Rates in Canada have also moved higher across the yield curve with the benchmark 5-year bond reaching a new 3-year high. Higher bond yields will lead to increased consumer borrowing costs and add to household budget concerns, already feeling the effects of higher inflation on real incomes. Bond prices and fixed income returns, which move inversely to yields, have declined year to date.

 

Basic economic results continue to improve.  GDP and job growth have been solid, and unemployment rates have trended lower. Going forward, tight labour market conditions and rising wages are likely to push inflation and could crimp corporate profitability.



U.S. corporate earnings continue to roll in. With more than half of S&P 500 companies reporting Q4 results, approximately 80% have reported results that have beaten analysts’ expectations. Corporate earnings growth is expected to be solid to finish 2021 but gear down significantly in 2022.

However, U.S consumer sentiment fell in February, coming in below forecasts to its lowest level in 10 years. Sentiment has been trending downward recently in both Canada and the U.S, with concerns over higher inflation, COVID protocols, and confidence in government policy to support the economy. 

 

Equity returns heading into 2022 are anticipated to be positive, but volatility is expected based on changing short-term conditions. However, retail investors should remain focused on longer term goals. Investment portfolio returns are less volatile over longer holding periods.

 

  • Short-Term View: Market volatility is back as investors attempt to anticipate central bank action to tame inflation.
  • Longer-Term Thinking: Markets are cyclical over shorter periods. Growth in equities over time is in alignment with long-term historical trends. Maintaining a balanced and diversified portfolio is key to your long-term investment success.
  • Logic Over Emotion: Perspective is key. Focus on long-term goals and timeframes.

Our Experts Say...

 

“Markets now face headwinds from rising inflation (which is leading the Fed to be hawkish and start hiking in 2022), supply chain and labour shortages, and uncertainty to normalized economic activity stemming from record Omicron infections and renewed lockdowns. Notwithstanding these risks and uncertainties, we continue to be generally constructive on credit and floating rate loans in the first half of 2022.”

 

Steve Locke

Chief Investment Officer, Fixed Income

& Multi-Asset Strategies

Mackenzie Investments

Core Fixed Income Specialist

 

 

 

Over the past 10 years, markets are positive. Perspective is key. Markets do react to short-term increases in volatility – see the grey lines below – but the long-term trend for markets is upward

 

 

Source: Morningstar Direct. Growth of $100,000 shown. Total returns from Feb. 10, 2012 to Feb. 10, 2022 in local currency.

Volatility is illustrated by the rolling 5-day minimum and maximum percentage change for each of the indices shown.