Keeping expectations on an even keel has been a challenge when it comes to the financial markets.
In 2022, we have experienced a rapid reversal in both direction and sentiment. With persistently high inflation, and with headwinds from the Ukraine war and the spring Covid shutdowns in China, the central banks have taken a more aggressive stance to try and temper inflation. This has prompted worries that, with slowing growth, economies may be pushed into a recession. The changing expectations and economic uncertainty have created significant volatility in the markets.
Indeed, humans often react unfavourably to uncertainty. Studies have shown that our emotions are a key driver of stock market volatility over shorter periods. One study suggested that roughly 75 percent of short-term market variation can be explained by risk aversion.1 This is because we often underestimate our ability to adapt.
Yet, history reminds us that markets and economies have continued to adjust and move forward from setbacks. As such, some balance may be warranted. We are emerging from a time in which record stimulus benefitted both the markets and economies, so a period of adjustment has been expected. Many company earnings thrived during this time and must now adjust as consumption patterns balance towards a post-pandemic world. Inflation has been a prevailing headwind and although it has been more than just transitory, consider that it also will not be permanent.
While certain market pundits are pointing to a recession, for now, labour markets continue to be robust and household balance sheets suggest consumer resilience. Recessions also come in different intensities and lengths; the past two recessions lasted only three and seven months in duration.2
Here at home, we are fortunate to be insulated from many of the challenges facing other nations. Our vast resource-based economy, including domestic energy production, serves us well. Consider that in the first quarter, Canada’s GDP grew at a rate of over three percent, whereas U.S. GDP contracted. As the growth sector has been punished more recently, the Canadian markets have been comparatively resilient, in part due to a larger composition in resources and commodity related sectors. At the same time, we shouldn’t forget that one of the key drivers of growth over recent times has been the technology sector, which is expected to continue to support future innovation, advancement and growth.
This is not to suggest that there aren’t challenges ahead. For now, economic uncertainty is expected to continue, however eventually the pendulum will swing back again. Uncertainties will always be with us, and finding balance amid the uncertainty is important.
While setbacks can happen too quickly to ignore, progress often happens too slowly to notice. This is why investing has been compared to planting trees: progress measured over months often shows nothing, yet over the long term can yield significant results. And, as Einstein once said, progress is “like riding a bicycle. To keep your balance, you must keep moving.”
1. https://www.nber.org/papers/w19818; 2. www.cdhowe.org