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COMMENT
Markets 2022: The Road Ahead. Topics include Federal Reserve rate hikes, Covid 19 economic fallout, Russia-Ukraine war, sanctions on Russia, inflation, market volatility. The guests today are: Earl Davis - Head of Fixed Income & Money Markets, BMO Global Asset Management Patricia Perez-Coutts - Portfolio Manager, PenderFund Capital Management John Zechner - Chairman & Founder, J. Zechner & Associates
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COMMENT
It's been a wild ride already this year. Patricia: This is not the first time it's happened. We have to be patient investors at all times.
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COMMENT
What does your world look like? Earl: He feels like the fixed income guy crashing the equity party. We'll see peak yields for the year shortly, by the end of July. Things will then calm down until January, when there will be a re-evaluation, depending on where inflation is. Base case is higher rates, not just for 2022, but also for 2023. The storyline will continue for the BOC. 75 is the new 50. He sees at least 2, and then they go back down to 50s. It depends when peak inflation hits, which he sees as September. But if it's not, then all options are open.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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COMMENT
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.
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John: He's been buying recently. Consumer discretionary stocks have been crushed. Travel will pick up again, especially domestic travel. Modified planes to take on more cargo. Solidified the balance sheet. Valuation looks impressive, down 75% from the pre-pandemic peak.
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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.
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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.
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