Any hopes for a less eventful start to the year in 2022 were dashed by the horrific scenes unfolding in Ukraine. While clearly there had been groundwork laid since the invasion of Crimea, no one would have expected Putin to be so bold as to invade all of Ukraine in such a brutal manner. Countries around the world responded with stiff sanctions that will be devastating to the Russian people, who did not ask for this war. Secondarily, the economic impacts will be felt for some time by the rest of the world. With a backdrop of persistent inflation, rising rates and geopolitical instability, risks have grown considerably - and our team remains diligent in analyzing these risks and their impacts on your portfolios.
One of the largest impacts is on the energy sector and on Europe in particular. In Europe, the cost to heat homes will skyrocket as the continent depends on Russia for close to 40% of its overall energy needs. The only solace is Spring has arrived and there will be time for some reinforcements prior to next winter, particularly in the form of LNG (Liquified Natural Gas) shipments. This supply shock is further exacerbated by years of underinvestment due to the shift away from fossil fuels in most developed markets. Against this backdrop, shares of energy companies have done well and will continue to play a crucial role in bringing stability to Europe and beyond in the near term. European shares could remain pressured – however, our focus on globally diversified companies in defensive areas such as consumer staples and healthcare will provide some insulation to potential volatility.
Another impact of this invasion is the supply shock - not just to oil but many other commodity and agricultural sectors such as steel and wheat where Russia and Ukraine are key producers. Inflation was already running out of control with a strong economic backdrop and stimulative monetary policies, and this will exacerbate it. Inflation of this magnitude is most damaging to lower- and middle-income families, and policy makers seem keenly aware of this threat. They have signalled a determination to raise rates at a much faster pace than previously predicted, regardless of economic risks.
This brings about a third impact and that is on the value of bonds which are tied directly to the path of interest rates. As interest rates rise, bond values fall. In the first quarter, the yield on the Government of Canada 10-year bond rose 100bps (1.4% to 2.4%) and accordingly long-term bonds fell close to 12%. We have long felt the ultra low interest rates experimented upon during COVID were unsustainable. Accordingly, we invested only in shorter term bonds, if at all, and our portfolios were significantly less affected.
A fourth impact emerging is on prices of companies with excessive valuations. Overall, equities have been relatively sanguine in the face of all these challenges. The TSX was positive in the quarter while international shares were modestly lower. Beneath these results however, we have seen investors shift away from speculative stocks with valuations that have defied logic for some time, and move towards higher quality shares in more defensive sectors.
It has been troubling to see the scenes unfold in Ukraine. Everyone is shocked at the brazenness of Putin, and we are keeping a close eye on events as they unfold. Overall, the direct impact on our portfolio holdings is limited with an immaterial amount of business exposure in Russia and Ukraine. Due to our defensive positioning, with a focus on quality companies with stable dividends, our portfolios have held up reasonably well. Going forward, we expect that volatility will remain elevated, particularly as rates rise, and we will continue to be prudent and cautious with your capital.
We welcome any comments or questions you may have, and we look forward to hopefully more positive outcomes in our next letter.
One of the largest impacts is on the energy sector and on Europe in particular. In Europe, the cost to heat homes will skyrocket as the continent depends on Russia for close to 40% of its overall energy needs. The only solace is Spring has arrived and there will be time for some reinforcements prior to next winter, particularly in the form of LNG (Liquified Natural Gas) shipments. This supply shock is further exacerbated by years of underinvestment due to the shift away from fossil fuels in most developed markets. Against this backdrop, shares of energy companies have done well and will continue to play a crucial role in bringing stability to Europe and beyond in the near term. European shares could remain pressured – however, our focus on globally diversified companies in defensive areas such as consumer staples and healthcare will provide some insulation to potential volatility.
Another impact of this invasion is the supply shock - not just to oil but many other commodity and agricultural sectors such as steel and wheat where Russia and Ukraine are key producers. Inflation was already running out of control with a strong economic backdrop and stimulative monetary policies, and this will exacerbate it. Inflation of this magnitude is most damaging to lower- and middle-income families, and policy makers seem keenly aware of this threat. They have signalled a determination to raise rates at a much faster pace than previously predicted, regardless of economic risks.
This brings about a third impact and that is on the value of bonds which are tied directly to the path of interest rates. As interest rates rise, bond values fall. In the first quarter, the yield on the Government of Canada 10-year bond rose 100bps (1.4% to 2.4%) and accordingly long-term bonds fell close to 12%. We have long felt the ultra low interest rates experimented upon during COVID were unsustainable. Accordingly, we invested only in shorter term bonds, if at all, and our portfolios were significantly less affected.
A fourth impact emerging is on prices of companies with excessive valuations. Overall, equities have been relatively sanguine in the face of all these challenges. The TSX was positive in the quarter while international shares were modestly lower. Beneath these results however, we have seen investors shift away from speculative stocks with valuations that have defied logic for some time, and move towards higher quality shares in more defensive sectors.
It has been troubling to see the scenes unfold in Ukraine. Everyone is shocked at the brazenness of Putin, and we are keeping a close eye on events as they unfold. Overall, the direct impact on our portfolio holdings is limited with an immaterial amount of business exposure in Russia and Ukraine. Due to our defensive positioning, with a focus on quality companies with stable dividends, our portfolios have held up reasonably well. Going forward, we expect that volatility will remain elevated, particularly as rates rise, and we will continue to be prudent and cautious with your capital.
We welcome any comments or questions you may have, and we look forward to hopefully more positive outcomes in our next letter.