Concerns about economic growth weigh on second half of 2022

At midyear, the main story thus far for investors can be summed up in a word: inflation. As the second half of the year progresses, attention will focus on when central banks will pivot from inflation to concerns about slowing economic growth, a chief investment officer says.

In Canada and the U.S., inflation has reached highs not seen in roughly four decades. Although the Conference Board of Canada recently said the Canadian economy isn’t expected to contract, some financial institutions predict the country will enter a “moderate” recession next year. For the U.S., the Conference Board recently stated that real GDP for 2022 will come in at 1.7% year over year, with a recession occurring later this year and into early 2023, slowing growth to 0.5% next year.

“Everybody’s using the word ‘pivot’ to describe [when and if] there’s [going to be] a pause in the [rate] hiking cycle and, beyond that, ultimately cutting rates once again to support a slowing economy,” said Chhad Aul, CIO with SLGI Asset Management Inc. Early signs already point to slowing growth in rate-sensitive parts of the economy, he said.

Those signs include a cooling housing market (particularly in Canada); slowing global manufacturing; price pressures from inflation and higher rates, which impact corporate earnings; and a tightening labour market.

Roughly 10% of Canada’s GDP comes from residential real estate activity, Aul noted. According to the latest Canadian Real Estate Association data, home sales in June 2022 were 24% below the record set in June 2021, as rising rates helped cool the previously hot market.

A cooling housing market subsequently reduces consumption and demand more broadly, Aul noted, slowing economic growth.

When growth becomes a concern, bonds — specifically, high-quality core bonds — become more attractive in a portfolio, he said. In a recent market update, Aul wrote that he and his team added to the core Canadian bond component of the portfolios they manage as yields became more attractive.

Among manufacturing data, orders at U.S. factories have steadily declined this year. Manufacturing “is the most cyclical part of the economy, so it tends to really lead those turning points in the economy,” Aul said.

He recommended “leaning away” from cyclical parts of the market and instead investing in defensive sectors such as consumer staples, utilities, telecommunications and health care.

Aul is also keeping an eye on the Q2 earnings season currently underway in the U.S.

“Broadly speaking, analysts’ expectations on earnings have not been revised down pretty much at all, given the dynamics of what’s been going on so far this year,” Aul said, referring to the impacts of inflation and higher interest rates.

“So far, the market has actually mostly been about the reduction in the multiple and how much it’s willing to pay towards those earnings,” he said. “But it hasn’t really revised down the earnings themselves. That typically is the next shoe to drop.”

When examining the Canadian labour market, Aul pointed to the country’s job vacancy rate. According to Statistics Canada, the national job vacancy rate increased to 5.2% in the first quarter from 3.6% in Q1 2021. The total number of job vacancies in the first quarter increased year over year to 890,385 from 553,480.

“If the jobs are not lost, it keeps some of these other concerns around consumption in check,” Aul said. “As long as people are employed, there’s at least some baseline support to consumption.”

Canada’s unemployment rate was a record low of 4.9% in June, as fewer people looked for work. In the U.S., the rate stands at 3.6%.

Aul’s advice to advisors when it comes to their clients is to stick to their strategic investment plans, make incremental changes within the portfolio to reduce downside risk, and add some additional upside opportunities along the way.

If they want to make any additional allocations to the portfolio, advisors should use the approach of “averaging in,” he said.