Welcome to Soundbites, weekly insights on market trends and investment strategies brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re taking a look back at 2022 with Justin Truong, senior manager, investment strategy with Mackenzie Investments. We talked about inflation, interest rates, and other risk factors that investors faced this year. And we started by asking him to summarize the market year.

Justin Truong (JT): Well, if I had to characterize 2022 with one word, it would be “tight.” And the reason why is because the word refers to the overall tighter financial conditions that we’ve seen, which has virtually been the only story that has mattered for markets this year. Looking ahead to 2023, there’s no question that financial conditions will remain a key theme and continue to have a heavy influence on the direction for markets.

The major theme of 2022

JT: The biggest one for markets has certainly been inflation, because it has dictated the direction of interest rates and, in turn, financial conditions. The war in Ukraine exacerbated the commodity supply shock coming out of the pandemic. And this placed further upward pressure on inflation globally. And although I believe inflation will remain structurally higher than many people think, I do see directionally inflation as having peaked and on its way down. There are plenty of signs of pandemic-induced inflation on the demand in supply side easing, when we look at things such as shipping costs, delivery times, inventory levels and many forward-looking indicators for demand. There will be pain. And that will be in the form of an economic slowdown in 2023. I believe it will be first felt in the manufacturing sector, due to the sizable inventory glut that many companies face today. But it’s not all bad news, because the demand side of the equation has actually driven a sizable portion of the inflation we’re seeing today. And so, as a slowdown materializes, this should cut down a significant portion of the excess inflation in the system.

The most obvious risks on the horizon

JT: The most obvious risk, in my view, is the energy crisis in Europe. The economic data and forward-looking indicators have all deteriorated materially in the face of higher energy prices. On a global scale, the risk is some form of contagion of higher energy prices being felt across the world, which keeps inflation elevated and, in turn, keeps central bankers from pivoting dovish. So, all in all, I think this would likely mean a deeper more-prolonged global economic slowdown.

Potential opportunities

JT: Well, the biggest opportunity that we see is currently in bonds. I mean, this view is predicated on a few factors, but in particular, it revolves around how bond yields have risen. And, of course, getting here has taken a lot of pain, as many of us know. But you now have U.S. Treasury bonds yielding over 3.5 to 4% and more in the investment grade in high-yield space. So, with higher yields, we’re finally receiving a more attractive income proposition from our bond investments, which has not in the case prior to this year. So, when I think about what is likely to unfold in 2023, where some form of an economic slowdown is likely, well then, that removes the upward pressure on yields. And we may actually see some price appreciation in our fixed-income investments.

Winning and losing sectors

JT: Yeah, I think the biggest winners this year have unquestionably been energy stocks which have seen their profits balloon. We’re talking about over 130% increase in earnings for S&P 500 energy companies as of the end of Q3. And investors have rewarded these companies handsomely as a result. On the flip side, this year’s biggest loser has been these new-economy tech stocks that we saw benefit greatly from the early parts of the pandemic, when central bankers essentially pinned interest rates to zero. Because many of these companies are unprofitable, with their future cash flows expected further on the timeline, that makes them most sensitive to interest rates. And as result they’ve suffered the most this year.

And finally, what’s the bottom line on the year that was 2022?

JT: Well, the title I’m using for many of my market outlook presentation today, as we wrap up 2022 is “Investing in the post-Goldilocks era.” We’re shifting from an environment of low inflation and very loose financial conditions to one with structurally higher inflation and tighter financial conditions. I think investors can expect more choppiness in markets, more modest expected returns from fixed income and equities. I also think that in this environment, where rates are no longer pinned to zero, investors will need to be more selective in their investments. And so, I think this new environment should provoke advisors to think critically on which asset classes will outperform — or at least be less effected — in this new post-Goldilocks era.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Justin Truong of Mackenzie Investments. Visit us at investmentexecutive.com where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.

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