Gregory Nott, Chief Investment Officer of Russell Investments Canada joined the CM Group to share his Fixed Income outlook and expectations for 2022 and beyond.
Steven Molina: Before we get to the questions, I do want to give our participants some background. We've had a long standing relationship with Russell Investments for over a decade now, and Greg has on numerous times provided timely and important feedback to our clients from especially an institutional point of view. It's not often you get a Portfolio Manager like Greg to present, so we're happy to have him here with us today. As I mentioned, Greg is the Chief Investment Officer with Russell and he's responsible for all aspects of investment management at Russell, including the fixed income pool and multi asset investment teams at Russell. Today's conversation will be focused on fixed income and getting Greg's views on the current environment based on many of the same questions we've been getting from our clients. What's going on with fixed income? It's been a steady performer for many of our clients’ portfolios over the years, but this year seems to be a little different and it's been difficult. Greg, fill me in. What's new? How are things in your world?
Greg Nott: Thanks, Steve. It certainly has been a challenging year in fixed income for sure, and I don't use this word lightly, but it really is unprecedented. The magnitude of the increases in the central bank rates, increase in bond yields, and unfortunately, the magnitude of the sell off or the drawdown in fixed income markets are all things that frankly we haven't seen in over 40 years in fixed income markets. So it really has been a very challenging environment. And of course, this is occurring at the same time that equity markets are struggling as well. So it's really been a challenge for investors this year for sure.
Steven Molina: Give us a brief explanation of what's causing bond fixed income values to fluctuate as much as they have this year.
Greg Nott: The short answer, Steve, is inflation. Inflation has been higher and has stuck around longer than both the market and the central banks. We're expecting this time last year or even in the Fall of last year. Chairman Powell of the Federal Reserve in the US was talking about inflation being transitory and how they expected it once the supply chains came back online and some of those COVID crisis accesses came out of the system, that inflation would rapidly fall back to target. Well, as we've learned through the first number of months of 2022, that wasn't the case. Those were contributing factors, of course, but that inflation was stickier. It was going to stay around longer and at a higher level than they had initially anticipated. Therefore, early in the new year, they did change their course and started aggressively increasing the central bank rates. And actually the Bank of Canada was one of the first to get started on this rate hiking cycle. Inflation is problematic for almost all financial assets. Inflation is not good for government bonds. Inflation is not good for corporate bonds. Inflation is not good for growth equities and inflation is not good for value equities. There's not a lot that does well. It's not good for real estate either, so there's not a lot of assets that perform as well in an inflationary environment. Unfortunately, that's what we have been in for really the last 18 months or so. I guess the good news is we think that we're near the end of that environment, that we do expect inflation to be coming down as we get into 2023 as a result of what the central banks have been doing and that they're probably pretty close to being done their hiking cycle. But again, because inflation has been so prevalent, central banks have had to be very aggressive in hiking interest rates and that has forced bond yields higher. And the basic math in bonds, if yields are increasing, prices are declining. And so with prices declining, that's where you've had your negative returns and your fixed income assets so far this year.
Steven Molina: Has there ever been a time in history that we've seen the central banks be this aggressive with their interest rate hikes?
Greg Nott: I mean, you'd have to go back to in the US anyways the local era he was chairman for Greenspan and so we're talking late seventies, early eighties, and they did not necessarily hike rates as quickly as what's happened this year, but they were hiking for an extended period of time. And so for some of you, you may recall in the early eighty's interest rates, 12, 14, 16%, inflation was running 12 to 13%. If you're unlucky to have to take out a mortgage at that point, your mortgage was probably 14%. Mortgage inflation was a real problem. In the late seventies, you had the energy crisis, President Carter and so on. Probably some of their policies probably made it worse. And so central banks back then needed to get very aggressive hiking interest rates to combat inflation. The difference then, though, was labor or wages. There was that wage price spiral because unions and labor was arguably a stronger voice or a larger component of the labor market. Since then, outside of some public sector unions, the number of people who are a member of a union has declined quite significantly.
And so there isn't the same sort of automatic price increases that we may have saw back then. But that was a good roadmap of where things have kind of occurred here. We think that because this time central banks were a little quicker to get going, they were still a little bit late. They should have been hiking rates last year instead of waiting until this year. They should have stopped quantitative easing. And we probably had too much fiscal stimulus as well. But I do think they're a little bit quicker than they were back in the seventies and eighties. And you don't have the same wage pressures as you had back then. We're not going to see double digit inflation and we're not going to see double digit interest rates and we're not going to see double digit mortgage rates. There are a lot higher than they were a year ago. Bond yields were 1%, now they're 4%. Mortgage rates have gone up quite a bit from where they were, but they're still in those mid-single digit range, which I think is close to where they're going to stop.
Steven Molina: We've been explaining to our clients for years, about the virtues of diversification, stocks go up and down, bonds add a layer of security. They don't necessarily move in the same direction. And when they do, they're usually not as volatile. Is this holding true in the current environment? We've seen some very big pullbacks in the bond market. When do we expect to see a recovery?
Greg Nott: A couple of key points you raised there, Steve. In the short term, the answer is no. They haven't really acted as that stabilizer in your portfolio. Unfortunately, we have seen a big negative price return in bonds. They've been positively correlated to equities when normally they're negatively correlated. So they've both moved down, quite frankly, in 2020 and 2021. They're both moving up together. Certainly over the last 12 months they've both moved down together and that's been a problem. If you have a balanced portfolio or 60/40 type portfolio, it's been a very challenging environment with both stocks and bonds selling off. And again, the reason for that is because this environment has been driven by inflation fears and inflation is bad for stocks and bonds. So the fact that they've moved together over this shorter time period is not a good thing, but is understandable. Going forward, though, I do think the relationship is going to change and that the protection element of fixed income or that stabilizer or that anchor in your portfolio is going to come back to the forefront. And the reason I say that is because at least based on our outlook and our expectations, is that we're in the midst of a transition from markets being driven by fears of inflation moving ever higher to fears of a recession and growth slowing significantly and in a slow growth environment or in a recessionary environment.
For more questions and answers with Greg Nott please contact Paige Hilton at paige.hilton@cibc.com to register and receive a copy of the full interview.
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