Page and Associates Ltd.

Family Wealth Management

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Short Term Pain for Long Term Gain

In the wake of the Bank of Canada’s surprising the market with a 1.00% hike of its overnight rate, CIBC Deputy Chief Economist Benjamin Tal provided a 4 minute video of his outlook on inflation, interest rates and the economy, and how investors should view these developments.

Key points:

  • Inflation should not be our main concern, because there are forces that will bring it back to more moderate levels. We should be more concerned about the cost to the economy of getting it back down.
  • The Bank of Canada’s goal is not to prevent recessions, but to limit inflation expectations to avoid a destructive wage-price spiral.
  • There is a 40-45% chance the bank will hike rates more than it needs to and cause a recession. They have signaled they want to go from 2.5% up to between 3 and 3.5%, but the difference between 3% and 3.5% may be the difference between a slowdown and a recession.
  • Inflation is a lagging indicator and usually peaks 4 to 6 months after the start of a recession, but no central banker will resist increasing interest rates when inflation rates are high.
  • Every recession in the past 40 years (except Covid) was helped – if not caused – by central banks hiking rates higher than they needed to.
  • There is still a good chance they won’t overshoot this time, because the significant increase from Covid-era lows are already starting to be effective at curbing demand, and there is still lots of strength to support growth.
  • So the rate hikes are probably already slowing growth, and if we do end up in a recession, it should be short and mild because
    o We have record high job vacancies
    o Consumers are sitting on about $300 billion in excess cash
    o The housing market is undersupplied and should support growth for years
  • Covid job losses were mostly lower income, higher earners took advantage of low interest rates to buy housing, so we borrowed some growth from the future
    o 20-25% home price declines would not be surprising
    o Rents did not rise during the pandemic, but they are rising now
    o Construction costs have risen faster than condo prices, so this sector is slowing now, but will rebound once supply and demand are back in balance
  • Equity markets have already priced in a lot of the bad news, and may have priced in more interest rate hikes than will be required.
    o If you have limited time horizon, equities are still risky
    o If your time horizon is 2-3 years, there are a lot of good opportunities out there.

Link to Video: https://link.videoplatform.limelight.com/media/?mediaId=3d73878551b043c7a33bd5f0ccbf09f9&width=540&height=321&playerForm=LVPPlayer&embedMode=html&htmlPlayerFilename=limelightjs-player.js&orgid=7e36bf0095db492cb2c8179d58eb0e29

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Interest Rate Commentary

With surging central bank rates and bond yields, GIC interest rates have also risen sharply this year, with top offers on 1-year terms now paying almost 4%, and 5-year terms over 4.5%. These are the highest GIC rates we’ve seen since before the 2008 Global Financial Crisis (Source: Cannex Financial Exchanges).

Bond yields spiked earlier this year on expectations that central banks would hike rates in response to building inflation pressures. The chart top right compares bond yields of all terms before the pandemic in blue, December 2021 in green, and June 2022 in red – quite the surge in a short time, especially in the shorter terms (Source: www.ustreasuryyieldcurve.com).

Top GIC rates are usually higher than government bond yields of the same term because of two risks: one is that you can’t redeem or sell a GIC before it matures, the other is that the bank issuing the GIC could fail. Investors control the locked-in risk by staggering GIC maturity dates and by maintaining some liquid cash deposits in case some cash is needed between maturity dates. They can also control the default risk by only working with institutions that are deposit-insured.

Because you can’t sell GICs before they mature, their reported current values are always based on the guaranteed principal plus any interest accrued, thereby masking the impact of rising market rates. You might be sad your interest rate is lower than currently available, but can be glad you won’t see any decline in value on your statement.

Because bonds can be sold in the market before they mature, their market values will drop when market yields increase. However, just like GICs, bonds will still mature at their full principal value, so investors who hold onto them after a decline will still earn the same yield they had expected when they bought them. In the graph below, we show a 5 year bond bought December 31 2021 at the then-current 1.27% yield, which would be worth about $106.50 with accumulated interest when it matures December 31 2026. By June 30 2022, market yields for a 4.5 year bond had risen to 3.00% implying about a 7% reduction in the value of the original bond to keep its yield aligned with the higher market yield. In the graph below you can see that as time passes and the maturity date gets closer, the market value of the original bond would gradually recover to 100% of its principal value, plus the investor would have all of the interest expected originally. The investor actually has an advantage since the interest payments can now be reinvested at higher rates than initially expected.

Once the market value has dropped in response to higher market yields, the effective return to maturity will be in line with the market yield, so there is no advantage to be had trading out after yields have already increased. In this case you would be sad that your market value has declined, but you might be glad that your yield to maturity is now much higher.

If market yields moderate again once inflation is back on target, bond prices should recover. If you are not keen on such fluctuations in the defensive sections of your portfolio, perhaps a series of GICs with staggered maturities would be a better fit.

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Recoveries Beat Bear Markets

Empire Life’s blog post of June 22 provided an interesting analysis of past periods of market contractions over 20%, and subsequent recoveries. One notable chart shown here:

The chart makes it clear that expansion phases usually last longer than contractions, and have a larger impact. The article compares this period with the 1970-1985 period of peak inflation and interests rates, noting similar depth and duration of corrections about -23% over 6 months, and recoveries of 55-70% over the following 18 months. Those recovery phases produce returns well above the market average.

Will investors see an environment of low inflation and interest rates similar to the past two decades or something closer to the inflationary environment five decades ago? Perhaps the answer is “somewhere in the middle”. But, here are a few things to remember:


• In either case and as history has shown, staying invested has proven to be a beneficial strategy for the long-term investor.
• Adding to your investments, particularly after large market contractions will likely help expedite your portfolio’s recovery.


Full Article: https://blog.empirelife.ca/blog/corrections-what-we-can-learn-from-the-past

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Patience will be Rewarded, Active Managers Still Beating the Benchmark

The below chart highlights the returns from May 1st, 2007 until yesterday’s close – a period of roughly 15 Years. This includes the Global Financial Crisis, the COVID-19 Pandemic, and countless corrections/world events in between.

We’ve shown the returns of 3 of Fidelity’s flagship equity strategies against the S&P 500 and TSX over that time period. Their returns against the indices have been staggering and serve as a reminder that not all active managers are created equal. We believe that Portfolio Managers Mark Schmehl and Dan Dupont have proven themselves as the “elite of the elite”, which is why they have been on our preferred managers list for some years already.

Volatility is part of investing; perhaps some investors have forgotten that over the past 3 years. Rather than trying to figure out when/how it will end — use downturns as an opportunity to add/diversify for clients with the appropriate time horizon and stick to your investing principles. Patience is the ultimate path to success.

15 Years of Returns: Fidelity Special Situations, Canadian Growth Company, and Canadian Large Cap

Source: Fidelity Investments Canada ULC