A Comment -- General Comments From an Expert (A Commentary)

Stocks vs. bonds. John: For most of the year, it's been an odd situation where both stocks and bonds have been decimated. He concurs that peak interest and inflation will be relatively sooner. In the past month or so, you've started getting divergence. On extremely down stock market days, the bond market rallies.

Recession jitters and emerging markets. Patricia: The picture is not the same everywhere in the world. Europe is perhaps on the weaker side than in NA, given its proximity to the Russia-Ukraine conflict. The basis point increase was just 25, a very shy statement compared to the Fed and BOC. In some countries, including Asia, inflation is much more contained.

Opportunity amongst the pessimism? John: He doesn't want to be Pollyannish, but he agrees that there is. We've heard before that stocks are one of the few markets that when things are on sale, people run away. Look at valuations that have come down and pick your spots. Ultimately, things will be fine. We'll have a short, shallow recession. Pay attention to earnings in the next month. He's been using cash to add to positions.

What to watch for in bonds. Earl: Coupons are much higher now since bonds have sold off, and that's the long-term gain that you'll get. He hasn't gone long credit, but a number of names are on his watch list, and he anticipates buying over the summer.

Political leadership and spending to battle climate change. Earl: A lot of political dynamics globally, not just in the US. Inflation handcuffs politicians. That's why he thinks interest rates are going much higher, because they have to crush inflation. #1 reason why politicians don't get re-elected is inflation. They don't want a recession that's caused by higher rates and demand disruption. So they'd rather have a recession caused by higher rates, so they could lower rates, and then they could spend.

Implications and extent of stagflation? Patricia: Not a situation of stagflation. Whether inflation is entrenched depends on expectations by central banks and how it's managed. Doesn't see expectations getting carried away just yet. Stagflation has only happened once or twice. If we manage our behaviours to contain demand, the supply will come in shortly. John: We're in stagflation right now, with inflation running 7-8% and we're probably into a negative quarter in the US again. But the question is how long will it last? The economy is turning off in the short term, and that will reduce some of the inflationary pressures. Inflation is a bigger political issue than higher interest rates, because it affects more of people's day-to-day living requirements. Earl: When he worked at a pension plan, the #1 environment they did not want to see was a stagflationary one, because there's no safe place to invest. Everything net loses real dollars. That's why it's important to break the back of inflation.

Deflation. Patricia: News story about companies paying customers not to return unwanted items. The cost of holding items in inventory is much higher now. If you extrapolate over the next 6 months or so, this could actually be dis-inflationary and affect perceptions of inflation. It wasn't so long ago that we were worried about deflation, not inflation. Though inflation is not as high as it was in the 1970s, everyone is feeling it abnormally in this environment.

Commodities this year. Andy Bell: Surged after February 24, when Russia invaded Ukraine. The world was worried that Putin's attack would curb supply on major commodities. Oil spiked into March, but hasn't returned and stayed at that level since. Oil is up 40% this year, but down from its peak. Natural gas in the US has had an amazing year, but has come off a bit due to the explosion at the LNG export facility. The world is tight nat gas. Warnings of disruptions in the hydro supply this summer could make nat gas prices spike. Copper is actually negative this year. A breakdown of industrial metal prices this year is possible. Corn surged too, and has been moving up recently due to fears of the Russian naval blockade on millions of tons of Ukrainian grain. Bottom line: Prices spiked after the invasion, but have since given up ground on recession fears.

How to find long-term value amid the chaos? Why is there a disconnect between commodities and the CAD? Patricia: USD has performed very strongly the last 2-3 months against all currencies. That's one reason the CAD is not doing well. Plus, people are thinking of a recession, and this has an impact, even a psychological one, on demand and the prices of commodities. Third, the supply chain is being supplemented by other countries now entering the market. For value in commodities, take a look at energy transformation, such as Chile producing low-cost lithium or Peru.

When to lock in medium-term bonds (4-8 years)? Earl: Tactically, late summer, as the bond market will rally from the peak into the end of the year. But strategically, if you have only one option, wait until January when we should get the pricing of any recession and inflation. One key thing is to look at active management. In this market, you don't want to be in a sailboat, you want to be in a rowboat. With passive management, you get 100% of the gains, but also 100% of the losses.

What do you watch each day in equities vs. bonds? John: Higher inflation and higher rates have hurt both. As the economy slows down and inflationary pressures recede in the back half of the year, we'll see a move back into bonds. We're already seeing this when bonds rally on down market days.

Signs that we're nearing a bottom. Patricia: In certain markets, we've already hit bottom. In NA, not just yet, perhaps in next few months. Emerging markets remain cheapest as a class right now. John: Technical indicators. Market peaked last November. We probably started a recession in February 2022, and markets typically bottom 6 months before the end of a recession. He's putting a bottom in any time. Bottom line is that he'll never nail the bottom, and stocks are cheap enough for him to use his cash balances to add stocks. Earl: He keeps watching the volume on stocks. The washout isn't just price, it's volume too. Even though we're down 20%, the volume isn't there yet. When he sees the volume come back, that's the end.

How to offset higher inflation effects on RRSP? Earl: Get some active management in there. Plus, high-quality, corporate bonds that yield at least 5%. Inflation-linked bonds, get ready to buy in 2023, not just yet. At some point, exposure to gold in 2023 makes a lot of sense.

When will housing get more affordable? Patricia: We'll have to keep an eye on incremental changes in the interest rates. When we think those have peaked, we'll see an inflection point in the housing market. Right now, it's hard to say. John: When the economy starts to roll over. This is not the same inflation valuation and financial mechanics problem as in 2008. Canada may see a downturn, but it won't blow up the way it did in the US.

Good time to nibble at banks and insurance companies? John: Insurance companies, he doesn't worry about. Canadian banks are fine, they'll pay their dividends. But a lot of the tailwinds will turn into headwinds. He wouldn't rush in there. He'd look at the US banks more, or at Canadian telcos to give more protection in a downturn. Patricia: Good banks in the global markets depend more on the spread. So with rising rates, they get to reprice their loans.