This year has so far been a wild one for investors and market watchers. Not only is the world continuing to deal with a two-year-long pandemic, but there’s also rampant inflation, rising interest rates and the first conventional war between two economically integrated European countries in years.

“It’s been an awful lot for the markets to digest in a short period of time,” says Garey Aitken, the Calgary-based chief investment officer for Franklin Bissett Investment Management. 

Russia’s invasion of Ukraine has been particularly unnerving for global markets. While the latter country’s GDP is smaller, Russia is the world’s 11th largest economy.

The two nations, together, have a significant influence on global prices for commodities already in short supply, such as oil, gas, certain metals, grains and fertilizers. West Texas Intermediate crude, for instance, shot up to nearly US$120 a barrel early in the crisis, while nickel prices broke their all-time highs.

There still a lot of unknowns with this conflict: How long will it last? Will other countries join the fighting? How will supply disruptions weigh on the post-COVID recovery globally and in Europe in particular?

“There's also the fear this situation could escalate further into Europe,” Aitken says. “We haven’t seen a geopolitical event like this in decades and it’s just been a big negative shock for markets to withstand, which is why both equities and fixed income markets have been under pressure.”

While the Bank of Canada and the U.S. Federal Reserve both raised their overnight rates by 0.25% in March – the first hikes since 2018 – the war has added risk to central bankers’ already fraught decisions about how to combat inflation. By simultaneously slowing global economic growth while boosting inflationary pressures, it increases the possibility of “stagflation,” the dreaded combo of inflation and economic stagnation that plagued western countries in the 1970s and early 1980s.

“These conditions are going to be pretty tough for investors,” at least in the short term, says Aitken. With consumer prices rising about 5% year over year, real yields on fixed income are almost all negative. Still, he adds, “I don’t think the situation warrants a rethink or a different approach to wealth preservation and creation.”

The merit of multiple baskets

While everything feels particularly uncertain now, which is no doubt making investors nervous, it’s important that investors focus on their long-term goals and don’t make any sudden moves.

 “Prudence would suggest you be appropriately diversified at all times,” says Aitken.

These days, investors can’t simply diversify by owning different asset classes – they must be diversified within asset classes, too. For example, over the last few weeks, global equities have lost value, but not everything has gone down. Canada’s S&P/TSX Composite Index, with its resource skew, has fared well. It’s up about 3.6% since January, while the S&P 500 has dropped by nearly 5.4% according to S&P Capital IQ.

It’s times like these that “really bring home the merits of active management,” Aitken notes. For instance, passive investors who own the S&P/TSX Composite Index would be up on the year, but they’d be up even more if Shopify wasn’t the index’s largest constituent. The firm is down 48% on the year, weighing on the index’s performance. Active managers wary of Shopify’s high valuation may have been underweight the company.

“You can have an active approach that looks underwhelming for a fairly long period, and then in a short space of time you can get a meaningful amount of relative performance versus a passive index,” Aitken explains. “Dislocations provide the opportunity for managers to demonstrate their value-add. Some of the value capture happens very quickly.”

Aitken adds that his Franklin Bissett Canadian Equity Fund, which he’s managed for more than 20 years, doesn’t hold any Shopify at all.

“That's been a wonderful tailwind for the last four months, I can assure you,” he says.

Value’s time has come

Whatever happens in the world next, Aitken says the decades-long chase for growth at almost any price is now done. Indeed, struggling tech stocks have been another headache for investors this year with many of the firms that did well during the pandemic now giving back a lot of their gains.

“That trade is over,” he explains. “Valuations are going to matter more over the next 10 years than they have over the past 10.”

Fixed income returns will also be unsatisfying for the foreseeable future, with rising yields pushing bond prices down.

“Well-managed equities will really have the upper hand over fixed income,” he says.

Dividend yield is one metric to watch, notes Aitken. Historically, dividends have generated between a quarter and a third of equity returns. If high inflation persists over years, stocks with dividend yields of 3% or 4%, and which grow over time, will both generate higher relative performance than the broad market and meet the challenge of providing income for shareholders against the backdrop of a fast-rising cost of living.

All of this is to say that though war and inflation have turned the tables on market expectations and prospects, some time-worn principles of successful investing continue to hold true.

Says Aitken: “The merits of diversification are alive and well.”
 

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