Points in Time: Q2 2022 - Leon Frazer
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Points in Time: Q2 2022
“Central banks are tripping over themselves to assure the
market that they’ll do whatever needs to be done to bring
inflation in line, even if it means increasing interest rates
to levels that will push economies into a recession.”
W h a t ’s n e x t ?
The first half of 2022 was one that most return in any given calendar year 25 times. interest rates to levels that will push
investors would like to forget. Oil, natural In all but two of those instances, U.S. economies into a recession. Although not
gas and some agricultural products investment-grade bonds posted positive a foregone conclusion, many economists
were up over the period while almost returns. In other words, when stocks are believe a recession is likely this year or
everything else produced negative returns. down bonds are almost always up. Just next.
not this year. If economies tip into a recession, we will
Nowhere to hide
Most investors have a mix of stocks Where do we go from here? almost certainly see corporate earnings fall
and bonds in their portfolios. The In our last quarterly commentary, we which is an additional negative for stocks.
diversification typically helps to ease discussed how the outlook for 2022 was Also, the longer it takes for inflation to be
the pain when one asset class turns in a becoming increasingly hazy. The picture is reined in, the higher rates will likely go and
negative performance. This year, so far, clearing but not necessarily in a good way. the longer they will stay high. This would
both stocks and bonds are down. This is imply a longer recession.
Central banks are tripping over themselves
incredibly rare. to assure the market that they’ll do The economists’ view is increasingly
In the last 94 years, the U.S. stock market whatever needs to be done to bring becoming the common view. Of course,
(S&P 500) has only produced a negative inflation in line, even if it means increasing it’s not easy to predict the future and
Figure 1: S&P 500 returns in post-war recessions (%)
9
n
9
2
75
1
58
4
1
-0
-9
ia
-4
-8
20
-6
-5
22
80
70
-
-
ed
1
90
07
73
48
81
60
57
53
0
20
20
19
19
20
M
19
20
19
19
19
19
19
19
0
-10
-20
-24 -24
-30
Current Median
-40
-50
-60
Source: Shiller data, Haver, DB Asset Allocation, Deutsche Bank
forecasting what might happen since were inflation drivers last year, like motor In any case, a recession seems to be
the pandemic has been a humbling vehicles, have also fallen dramatically. already priced into the market (figure 1
experience. So, what conditions need to shows S&P 500 returns in each recession
What’s priced in?
be present for the economy not to fall into since WWII). At its worst point in the first
It looks like there’s a case to be made that
a recession? It all comes down to inflation. half of this year, the S&P 500 was down
a potential recession could be relatively
The quicker we get inflation under control, 24% from its high which is fully in line with
mild with the employment situation
the better chance rates won’t rise to a typical recession.
being a big pocket of strength. Currently,
levels that will totally choke off economic Of course, things are changing rapidly and
Canada’s unemployment-to-job-vacancy
growth. That could help ensure a soft it will likely take until at least the end of
ratio is 1.3 which means there are almost
landing. next year for the economy, and perhaps
enough jobs for every Canadian looking
There are many signs that the economy for one. This is the most favourable society, to be somewhat back to normal
is cooling which should lower inflation. number on record. versus pandemic times. Buying in a bear
Consumer confidence is very low market (down 20%) has historically been a
If we do have a recession, jobs will be
which should impact spending. Many great investment over the long term, but
lost but we’ve never entered a recession
commodity prices have come down from it’s not always the best in the short term.
with an employment situation as good
recent highs. For instance, lumber prices We’ll only know that in hindsight.
as the one we’re in now. People with jobs
are down over 50% since March. It’s a Sources: FactSet, Fidelity, Bloomberg
generally pay their mortgages and spend
sign that rates are impacting housing
money, which helps to keep the economy
demand which has been a big inflationary CWB Wealth Management
going.
factor. Demand for many goods, which Investment Team
Leon Frazer Quarterly Commentary: Q2 2022 page 2Fixed Income
WAT C H I N G The inflationary effects of COVID-19 Investment-grade spreads have increased
The first half of 2020 was tough for fixed stimulus, supply chain disruptions and slightly over the quarter while non-
income markets. Usually, bonds are a the Russia-Ukraine war continue. While it’s investment-grade spreads increased
reliable port in a storm when equities fall, uncertain how long the influence of these more substantially. A potential recession
but not so far this year. The Canadian Bond disruptions will last, central banks have would likely have a disproportionate effect
universe was down over 5% on the quarter made it clear that taming inflation is the on weaker companies as their cost of
and over 12% year to date. Although it priority. To do so, they’re willing to sacrifice borrowing rises.
was expected that interest rates would economic growth and employment. We The yield curve has significantly flattened
rise this year, the speed and magnitude expect central banks will continue to raise and is inverted at certain points. A flat yield
of the increase was not foreseen by most rates until there’s real, lasting progress in curve is a signal of a slowing economy,
observers. For bond investors, it was a bringing inflation down. If it’s persistent, while an inverted curve means we could
period to forget. this could mean rate increases for the see a recession (see figure 2).
remainder of this year and even into next.
Figure 2: Canada Curves – June 2022
Current 3 months ago 1 year ago 2 years ago
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
Source: Bloomberg
Leon Frazer Quarterly Commentary: Q2 2022 page 3“We expect central banks will continue to raise rates until there’s
real, lasting progress in bringing inflation down. If it’s persistent,
this could mean rate increases for the remainder of this year and
even into next.”
THINKING Credit spreads have increased substantially comfortable holding an overweight
year to date from unusually low levels. position in credit bonds.
The market is forecasting that the Bank of
This indicates that markets seem to have Given our belief that most of the potential
Canada overnight rate will end the year
already discounted a lot of potential bad movement in the yield curve is already
somewhere between 3% and 3.5%. That’s
news. complete, we’re maintaining a slightly
a huge increase in a short period, given
underweight exposure to duration.
the rate was 0.25% at the beginning of the
DOING Sources: FactSet, Bloomberg
year. The 10-year bond yield is somewhere
between 3% and 3.5%. The market believes Although it’s a struggle to find good value
in federal bonds, they still have a purpose Malcolm Jones, MBA, CFA
inflation will be brought under control
for risk control, so we’re maintaining Senior Portfolio Manager, Fixed Income
and that yield curve movement from here
should be muted. If this is the case, bonds exposure in short-dated Canada bonds.
should be able to earn their coupons We don’t see a significant recession
going forward. happening in the near term, and we’re
Canada
WAT C H I N G significant demand reduction, which may the quarter. Open Text is one of the few div-
The more aggressive stance in rate hikes re- be brought on by persistent high prices, idend-paying Canadian technology stocks,
cently adopted by central banks has led to combined with the effect of higher interest and we continue to like it long term.
fears of a recession in the coming months, rates on consumer consumption. Recent
and investors have been selling stocks as weakness in energy stocks was a reflection THINKING
a result. The Canadian equity market, as of this concern, though they appear to be The mood within the equity space
measured by the S&P TSX Index, was down rebounding somewhat. The energy group has changed considerably since last
13.2% in the second quarter. Our portfolio was the strongest performer in Canada in quarter. We’re mindful of two things. The
was a relative outperformer in the quarter. the second quarter, being down only 1.9%. first is sentiment, which is driving the
The classically-defensive sectors, consumer Most commodities outside of food and trading activity in the equity market at
staples and utilities, were relatively strong energy have pulled back recently, consis- the moment. Market sentiment turned
performers in the quarter. This shows con- tent with an overall slowing in the econo- decidedly negative in June on the back
cern about possible slowing growth going my, or anticipation thereof. This is shown in of a surprisingly high inflation number.
forward and investors moving towards Bloomberg’s commodities index chart (see This happened very quickly. It’s entirely
these more earnings-stable areas. figure 3). possible that sentiment will reverse just as
On the energy front, we continue to see oil Information technology and health care quickly, as a response to an unexpected
in excess of $100 per barrel. We’ve men- were the weakest sectors, down 30.7% and positive data point or event. These
tioned in the past that there’s a supply issue 49.6% respectively. We avoided the worst reversals of sentiment are not forecastable,
side story, and we’ve yet to see significant of that, having no health care stocks in the and it’s important to be in the market
investment in oil production from industry. portfolio, and holding Open Text within the when they happen.
Equilibrium at a lower price level will require technology space, which was down 7.7% in
Leon Frazer Quarterly Commentary: Q2 2022 page 4Figure 3: Commodities index chart Year to Date
140
Bloomberg Ex-Energy - Price
135
130
125
120
115
111.57
110
Jan Feb Mar Apr May Jun
Source: FactSet
We must also bear in mind that, by nature, DOING Sources: FactSet, Bloomberg
the data describing economic growth
We had a fairly quiet quarter with respect Gil Lamothe, CFA
refers to what has already taken place. The
to portfolio trading activity in Q2. We Senior Portfolio Manager,
equity market is forward looking and often
remain cautious when markets are not Canadian Equities
looks beyond the latest data to where
trading on fundamentals. We saw several
things will be in six months. It wouldn’t
dividend increases in the quarter. The
be unusual for the equity market to begin
portfolio now has seen 20 of its 31 stocks
rallying as weak economic numbers
increase their dividend this year. We’re very
come out, especially if the weakness was
happy with that and while the market may
expected.
be correcting, we’re being paid to patiently
wait it out.
“It wouldn’t be unusual for the equity market to begin rallying if
weak economic numbers come out, especially if the weakness
was expected.”
Leon Frazer Quarterly Commentary: Q2 2022 page 5U.S.
WAT C H I N G The laurels for the worst performance impacted by the current environment.
The current economic environment were shared by consumer discretionary, Figure 1 shows the earnings revision
reminds us of Aesop’s fable, The Boy Who communication services and the infor- trajectory for the S&P 500. It’s clear from the
Cried Wolf. Just as the wolf in the fable mation technology sector. The econom- exhibit that more companies are starting
showed up eventually, so did inflation, sur- ically-sensitive energy sector remains an to feel earnings pressure in the current
prising economic and market participants. outlier with about 32% returns on a YTD environment, and the market seems to
Over the past 6 to 12 months, we saw the basis, while bonds, commodities and even catching up to it. Averages, while great in
inflation narrative shifting from “transitory” crypto all ended in negative territory. certain aspects, can be deceiving, creating
to “higher for longer” to now “we need to opportunities for investors like us. We don’t
tame it at any cost”. It showed up when it THINKING believe that earnings for all businesses will
was least expected, led by a confluence of In an environment where consensus be impacted equally and it’s our job to
factors. While many of these were unpre- is calling for a recession due to higher find ones that will overcome the current
dictable, one wonders how a decade-long interest rates resulting from persistence environment and where the price is already
underinvestment in resources and global of inflation, the odds of predicting any discounting significantly.
supply chains went unnoticed. economic outcome with a degree of DOING
Given all this uncertainty, it would be fair certainty are low. Our job, as stewards of
capital for our clients, is to make decisions During the quarter and first half of
to characterize the first half of 2022 with the year, our U.S. portfolio showcased
the word “fear”. We saw fear across asset where odds are favourable and to act
deliberately when the world around us resilience versus the S&P 500 leading to
classes and markets. The first half of 2022 relative outperformance despite having
marks one of the worst performances seems to be falling apart. Our edge is
in analyzing businesses thoroughly and no exposure in the energy sector. We
for the S&P 500 since 1970, with markets give little importance to short-term
yielding negative 20% total returns for the taking advantage of prevalent fear by
buying at lucrative valuations. performance and focus on investing to
period. Within equities, defensive sectors enhance the portfolio for the long run.
such as utilities, staples and healthcare We’re fully focused on how long-term
have been the best performing sectors. economic prospects of businesses are Taking advantage of the ongoing fear,
we initiated a position in Aramark, one
Figure 4: S&P 500 Earnings Revisions Breadth
50%
40%
30%
20%
10%
0%
-10%
22
22
21
22
21
1
21
22
2
22
21
21
21
21
21
1
21
22
2
1
r2
r2
l2
ay
ay
g
ar
ov
ar
ec
p
ct
b
b
n
n
n
n
l
Ap
Ap
Au
Se
Ju
Ju
Ju
Ju
Fe
Fe
Ja
Ja
M
M
M
M
O
N
D
Source: FactSet, Morgan Stanley Research
Leon Frazer Quarterly Commentary: Q2 2022 page 6“The current economic environment reminds us of Aesop’s fable, The
Boy Who Cried Wolf. Just as the wolf in the fable showed up eventually,
so did inflation, surprising economic and market participants.”
of the leading catering companies in the in Costco, Nvidia and Microsoft. Overall, we Sources: FactSet, Bloomberg, Morgan Stanley Research
world, with a mid single-digit structural continue to stay disciplined and focused
growth profile and operational turnaround on the long term by investing in high- Liliana Tzvetkova, CFA
potential. We exited our position in P&G quality companies at lucrative valuations Portfolio Manager, U.S. Equities
and Republic Services as we deemed which we believe will lead to superior Saket Mundra, CFA, MBA
risk/reward to be more lucrative in other returns for the portfolio. Portfolio Manager, U.S. Equities
opportunities, and redeployed the capital
Q 2 202 2 D iv iden d Per forma n ce S u m m a r y
Canadian Dividend Portfolio
Number of companies in the equity portfolio 31
Number of companies that declared an increased dividend 20
% of companies that declared an increased dividend 64.5%
Weighted average of dividend increase 5.7%
Consumer Price Index Increase (YoY*) 7.7%
Equity portfolio dividend yield** 3.9%
S&P/TSX dividend yield 3.2%
Top 10 Dividend Growers
CANADIAN NATURAL RESOURCES LIMITED 27.7%
CANADIAN TIRE (NON VTG A) 25.0%
CANADIAN NATIONAL RAILWAY 19.1%
METHANEX CORP 16.0%
AGNICO EAGLE MINES LTD 14.3%
SUNCOR ENERGY INC 11.9%
INTACT FINANCIAL CORP 9.9%
BROOKFIELD ASSET MANAGEMENT CL A 7.7%
ROYAL BANK OF CANADA 6.7%
BROOKFIELD RENEWABLE CORP 5.3%
* Estimate from Statistics Canada May 31 2022
** The dividend yield is based on the Leon Frazer Canadian Dividend Fund using the target weight for cash
Source: Leon Frazer & Associates, June 30, 2022
Leon Frazer Quarterly Commentary: Q2 2022 page 7Vancouver • Calgary • Toronto
info@leonfrazer.com
www.leonfrazer.com
Leon Frazer & Associates recommends clients seek investment-related tax, legal and accounting advice from their own professional advisers. This information is not intended to be relied on as specific investment advice to any reader. If you are considering an investment, consult your investment professional. All chart data is as at quarter
end. To ensure comparability and unless otherwise stated, the indicated rates of return for each Index or Composite is the historical annual compounded Total return, which includes changes in price or unit value as well as reinvestment of all distributions but does not take into account sales, redemption, management, distribution, or
optional charges or income taxes payable by any unitholder that would have reduced returns. Actual returns in a managed account will be reduced by investment management fees, transaction costs and taxes applicable to the account. The value of an investment is not guaranteed, may change frequently and past performance may not
be repeated. The investor may not get back the amount invested. Leon Frazer & Associates is a business name of CWB Wealth Management Ltd. (“CWB WM”). CWB WM is a subsidiary of Canadian Western Bank, and a member of the CWB Financial Group. © CWB Wealth Management Ltd., 2022. All rights reserved.
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