Portfolio Update

Global equity markets partially recovered from the initial selloff following Russia’s invasion of Ukraine in February. Year to date, the S&P 500 Index is down 5.7% in Canadian dollar terms, the S&P TSX is up 3.8% and the MSCI World Index is down 6.2%. Longer-duration fixed income securities have continued to show weakness as monetary policy has begun to normalize. Notably, the 30-year Government of Canada bond suffered a 15% loss over the last three months as its yield rose 70 basis points. Our investment strategies have performed well, in large part due to our exposure to commodity and defensive sectors, shorter maturity fixed income securities, and the avoidance of companies trading at rich valuations.

We continue to believe the global economy will grow despite risks arising from inflation and the conflict in Ukraine. The spillover effect of the Russia/Ukraine war is not expected to be felt equally around the world. Russia and Ukraine will face severe contraction, however, these two countries account for a very small portion of world growth. Meanwhile, Europe is more at risk of an economic slowdown due to its dependence on Russian energy supplies. The economies of the U.S., Canada and China should be sufficiently resilient to withstand higher inflation while avoiding a recession.

Risk to Outlook: Inflation

Energy costs and food prices made the largest contributions to headline inflation in the U.S. during the month of February. The U.S. Consumer Price Index (CPI) for all items accelerated to 7.9% year-on-year in February, and we estimate that the short-term impact of higher energy and food prices could add around 2% to CPI, implying headline inflation near 10%.  As noted in our “Economic and Capital Markets Outlook – April 2022”, Russia and Ukraine are important producers of agriculture, energy and industrial metal commodities. The price of these commodities has surged on expectations of supply disruptions (Chart 1). As spending on food and energy tends to be inflexible, households will likely have to scale back spending on discretionary items if disruptions, resulting from the war, are sustained. While this raises the risk that growth will be lower than previously expected, it does not imply that a recession is imminent. We note that the share of personal disposable income allocated to food and energy in the U.S. remains well below the historical average (Chart 2). In addition, while savings rates have moderated back to average levels in the U.S. and Canada, excess savings still represent more than 10% of GDP in both countries, suggesting households may have a buffer against elevated food and energy prices.