This has been a difficult year in the financial markets. Inflation continues to run at levels not seen in decades. The Russian war on Ukraine has exacerbated this scenario by disrupting agricultural and energy supplies. Reducing inflation is a difficult task and not achieved overnight. Central banks continue tightening the money supply and increasing interest rates to battle inflation. This difficult, but necessary, monetary policy will likely continue throughout the balance of this year and into 2023.
Rising interest rates have a negative impact across a range of investment categories. Rising rates have a cooling effect on the economy and bring excesses back into balance. The risk, however, is that they go too far and tip the economy into recession. Year-to-date, the U.S.-based S&P 500 is down 16.7% (in Canadian dollars) while the TSX Composite in Canada has declined 11.1%. This volatile and negative performance will likely continue over the balance of the year.
Despite this challenging environment, we do see glimmers of improvement. Over-heated housing markets are cooling off. Stretched supply chains are catching up. Labour markets remain tight, with the developed world virtually fully employed. In fact, labour shortages abound. Inflation itself may have already peaked.
While this is a gloomy year in terms of performance, it is important to remember that equity markets look forward. At some point in the not-too-distant future, the stock market will begin to discount a lower inflation world and either a recovery from recession or a slower but steadier growth scenario.
Our response to this environment is threefold. First, maintain higher than normal cash balances in your portfolio. This helps protect against the downside and provides the opportunity to buy great companies at discount prices. Second, remain focused on the long term and see through to the next cycle. Third, continue to emphasize investing in companies with strong fundamentals. The companies we invest in generate significant excess cash. As a result, many of these companies are dividend payers with long histories of steady increases. Furthermore, the majority of the dividend increases announced in the last year have at least kept pace with the rate of inflation.
Long term returns are achieved by remaining invested in high quality companies, and not trying to guess when to enter or exit volatile markets. A tested maxim for successful investing is “Time in the markets, not timing the markets”. We will continue to monitor your portfolio carefully as we manage through this challenging period.