No party lasts forever, and the more you celebrate, the worse the hangover. It’s a lesson markets and party-goers alike seem to forget every time someone offers them one more shot, whether of tequila or of financial stimulus – and one that has everyone reaching for Advil after the first half of 2022, as the harsh light of morning brings headaches in the form of eye-popping rate hikes, negative returns and higher mortgage payments for variable holders.
It’s also the lesson at the centre of Canso Investment Counsel Ltd.’s Corporate Bond Newsletter for July 2022.
“The first quarter financial market bruising exploded into full blown carnage by mid-year as second quarter returns pushed deeper into negative territory,” the newsletter reads.
“Stocks, bonds, crypto, real estate – if you owned it, it went down in value … If you borrowed money to leverage your way into greater wealth, your banker wants to speak with you. Rarely have so many, lost so much, so quickly.”
It’s a hangover the fund managers at Canso had been warning about for some time, as central banks were forced to hike interest rates to combat inflation hovering at levels not seen in 40 years.
In July the Bank of Canada raised its target interest rate by 100 basis points (bps), or 1.0%, above what most experts were expecting, while the European Central Bank raised rates 50bps, “double what they promised in just a few weeks.”
The Canadian yield curve inverted, suggesting that while markets believe central banks will get inflation under control, that adjustment won’t come without a negative impact on economic activity.
“Investor concerns over the fallout from aggressive central bank rate tightening took hold in the second quarter,” the newsletter said.
“Several markets recorded double digit losses, as investors fled the riskiest assets. Equity markets, followed by high yield bonds, posted the largest drawdown.”
The most speculative issuers are expected to be among the first to struggle with tightening liquidity across capital markets, and Canso expects increased default activity in the months ahead.
“While still relatively modest, this year has seen the most default activity since 2020. J.P. Morgan calculates nine companies defaulted in the U.S. this year totaling U.S. $17.2 billion, while another six companies completed distressed exchanges aggregating U.S. $9.7 billion,” Canso writes.
“The tally through the first half of 2022 is nearly twice last year’s full year total of U.S. $13.9B.”
For Canso, the current pain in the markets is part of a normalization needed to bring markets back from an era of excess.
“Markets lurch from crisis, to rescue, to stabilization, to recovery, then normalization,” they said.
“Higher yields and wider spreads have put the ‘income’ back into fixed income. While the return potential afforded by credit markets is more interesting than six months ago, we do not believe potential returns offset the risks we see ahead. We are continuing to value quality and liquidity above all else.”
Read the full July 2022 Corporate Bond Newsletter.
The views and information expressed in this publication are for informational purposes only. Information in this publication is not intended to constitute legal, tax, securities or investment advice and is made available on an “as is” basis. Information in this presentation is subject to change without notice and Canso Investment Counsel Ltd. does not assume any duty to update any information herein. Certain information in this publication has been derived or obtained from sources believed to be trustworthy and/or reliable. Canso Investment Counsel Ltd. does not assume responsibility for the accuracy, currency, reliability or correctness of any such information.