By Scott Blair
It is truly a terrible turn of events that Russia has gone to war with the Ukraine. It is certainly painful to watch the images that come out of what was a lovely and productive nation. We are heartbroken for those suffering through this conflict.
Pivoting our role as advisors, we consider what it means for our clients.
One way to get an understanding is to look back in history to see what happened during previous wars. Astonishingly, if you Google “wars since 1990” there have been no less than 77. Most are civil or regional wars or insurrection, but the message clearly is that the world seems to always be at war. The two which are most recognizable are the Gulf War of 1990 and the war in Afghanistan from 1996 – 2002. These are somewhat similar in two ways. First, they involved most of the global world powers in one way or another and second, they were the catalyst for oil supply shocks. Shortly after the beginning of each of these conflicts, the S&P 500 in the US rocketed back. During 1990 the S&P was down -3.06%. The following year, it was up +30.23%. Similarly at the end of the war in Afghanistan, the S&P was down -21.97% and in the following year, 2003, up +28.36%. This is similar for the Canadian index, the TSX. Also a good reminder is that the TSX 12 month return to time of writing is still +19.01%.
North American Markets
In North America, we are for the most part insulated from the conflict. Canada and the US rely very little on imports from Russia, the Ukraine and for the most part Europe. This is a good thing. Better yet, we believe we are in what is being called a commodity super cycle. Pretty much every commodity you can think of is not only up but continuing to climb to new highs. Copper, aluminum, iron, zinc and now gold has broken out of a long trading range and certainly oil & gas. Canada has all this stuff and right now the producers are making money hand over fist. Keep in mind that we only really have 3 sectors here: Energy (oil & gas), Materials (copper, iron, etc.) and Banks and there is a very high correlation between all three sectors, 86%. It makes sense because when commodity prices are as high as they are the producers like Canadian Natural Resources and Suncor are hiring and building new facilities to fill the demand and to do so they go to the bank and borrow to do so. The TSX will be the happy beneficiary of all this. Over the last 6 months, we have been moving more back towards Canada within portfolios.
As such, we will see continued inflation for now. At time of writing oil is at US$128 and climbing. Gas is $1.85 at the pump. This will translate into higher transportation costs which include not just us driving our cars around but ships, trains and trucks delivering things like groceries to the shelfs. Those transportation costs will be passed on to us the consumer.
In response to elevated inflation levels, interest rates will follow. We don’t expect an interest rate shock but the Fed will soon be on the move up and Canada has already begun with it’s last policy rate increase to 0.50%. Consensus would suggest another 1.0% over the year which will translate into higher mortgage and lending rates.
What does the Bond Market Say?
Again, historically, the bond market is a fairly accurate predictor of the equity market. The real worry that most have is, are we about to enter the next recession? The short answer is “probably not”. An indicator of a coming recession typically is an inverted yield curve. Short term bond yields (2yr) become higher than longer term yields (10y). That is not the case at the moment. The difference between the two (spread) has narrowed BUT it is still half of one percent. When the spread narrows to this level the shortest period to the next recession is 20 months…20 months. The longest 43 months so according to the bond market we are not looking for a recession for almost two years.
The human cost in the Ukraine is the real tragedy.
The financial cost to us should ultimately not be tragic and if we look at previous examples may even prove to be positive for Canada with the rise in commodities.
As always, if you would like to know more or just ask questions, let us know, we’re happy to talk. If you are interested in potential changes by adding more Canadian participation or adding some energy, let us know and we can discuss how that might look for you.
Photo by Priscilla Du Preez on Unsplash