In the August edition of The Informed Investor, Moiz Divan, CFA, a Portfolio Advisor at RBC InvestEase, explores the latest developments in inflation and shares his thoughts on where the markets could go from here.

Policymakers have maintained a strong focus on taming high inflation this year. Are there signs that their efforts have been effective?

RBC Global Asset Management’s (RBC GAM) chief economist Eric Lascelles recently published a memo that shared a few of the reasons why inflation is likely to be peaking(opens new window). One of those reasons is the commitment to get inflation under control that policymakers have demonstrated. Two others are the improvement of supply chain issues and the decline of commodity prices like gas, both of which have been key drivers of persistently high inflation.

Lascelles’s memo also notes that real-time inflation measures based on online prices are now flattening out and have even begun to show signs of decline. That doesn’t mean that we’ll see a steady course of declining inflation numbers, but it does signal progress.

One of the problems with assessing inflation is the lag between the data being collected and the calculation and publication of official inflation numbers for a particular month. Another is that policy actions to lower inflation, like raising interest rates, take time to have their cooling effect on the economy. For example, higher interest rates increase borrowing costs on loans to both consumers and businesses, and it remains to be seen how consumer and business spending will evolve in response.

We’ve seen both the stock and bond markets recover a bit in July 2022. What has driven that recovery and what could it mean for the path of markets going forward?

Whether you’re a conservative or growth-oriented investor, you’re going to have good return years and bad return years. 2022 has been a tough year for a number of different reasons, particularly with the challenge of both markets slumping at the same time, a phenomenon that historically we’ve rarely seen.

Bond markets declining alongside stock markets and the general market volatility so far this year have been most strongly influenced by the current rising interest rate environment. The market’s recent optimism signals confidence that policymakers will get inflation under control and that their interest rate policies will normalize.

That’s not to say the market’s mood won’t change. A lot of uncertainty remains around the way in which various factors important to the markets and to inflation will develop. What we can say is that the pullback that global stock markets have experienced has decreased some of the risk that comes with high market prices – like the ones we saw at the end of 2021. Eric Savoie, MBA, CFA, an investment strategist at RBC GAM, noted in a July 2022 market update(opens new window) that RBC GAM’s composite of global valuations was signaling that the overvaluation of stocks measured at the end of 2021 had been eliminated, which has increased the return potential that we can expect going forward. This is especially the case for non-US markets, which have suffered the most significant declines.

The month of July has also seen positive returns for Canadian and global government bond investments in the RBC InvestEase portfolios. Our team believes that, going forward, bonds prices are unlikely to see the kind of steep downward adjustments that they did at the beginning of the year. Both interest rates and inflation would have to get much worse than the market currently anticipates for that to be likely.

In addition, both interest rates and bond prices have reached levels where we believe there is good return potential going forward. Investors are poised to earn more interest income due to higher rates and are more likely to benefit from bond price increases from the historically low levels bond prices managed to reach. Possibly more importantly, this increased return potential for bonds also means that they’re better positioned to offer diversification benefits to investors should stocks take another dip.

As we discussed in our May 2022 letter(opens new window), the ability of bonds to buffer volatility is one of the key reasons they are included in all but the most growth-oriented of our RBC InvestEase portfolios.

Any final thoughts to share with investors?

If you want additional insights about what’s going on in the market and the appropriateness of your investment plan, please don’t hesitate to reach out to the RBC InvestEase Portfolio Advisor Team. We are firm believers in the helpfulness of a human voice when it comes to achieving success as an investor. I truly enjoy the conversations that I have with our clients where I’m able to help them maintain a long-term mindset and feel a little more comfortable with their investment journey.