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Mackenzie CIO, Lesley Marks, on inflation, energy prices and the future of net zero
After several years of solid gains, some of Canada’s biggest pension funds are now feeling the impact of roiling public equity markets and reporting their first quarterly losses in a long time. Not surprisingly, Canadian institutional investors are keeping a close eye on what central bankers will do next to tame inflation. With plenty of uncertainty on the horizon, we turned to Lesley Marks, Mackenzie Investments’ Chief Investment Officer of Equities to find out what macroeconomic factors she’s most focused on and where she sees inflation, energy prices and the push for a sustainable economy headed in the coming months.
Macroeconomic factors like inflation and the prospect of a recession loom large right now. Which macroeconomic development do you think will play the biggest role in your investment decisions in the coming months and why?
We’re feeling fairly confident in our view that inflation has peaked – what we’re most focused on now is the pace of the decline in inflation. This will guide the pace of future monetary policy tightening. Central bankers in the major economies have all unified to fight inflation with higher interest rates despite the risk of a hard landing or recession in their respective economies. If inflation proves to be stickier than expected, central bankers will have to continue to administer the strong medicine of large interest rate increases until demand slows and upward price pressure eases. However, if inflation rates start to fall quickly then central bankers will have confirmation that their policy decisions have achieved their desired outcome of balanced supply and demand and they can ease off in the pace of interest rate increases.
Is there an additional, risk that central bankers make a policy error that leads to unintended consequences and if so, could failure to achieve the desired outcome undermine confidence in the power of central banks and their toolkit?
As a general guideline, the mandate of most central banks is to promote their economy within the confines of price stability. The post-pandemic recovery has caused severe dislocations given lockdowns, supply disruptions and extreme shifts in demand from goods towards services. This has made the central bankers’ job more difficult and likely caused the policy moves to have a greater lag in their impact.
We have heard loud and clear the hawkish language from both the Federal Reserve and the Bank of Canada that they are committed to the monetary tightening strategy until they see inflation subside so it is unlikely they will fail to achieve the desired outcome. Although they would prefer to have a soft landing as the economic outcome, they seem willing to accept a hard landing if that is what it takes to achieve price stability.
Because of the well understood history of double digit inflation and interest rates in the 1970s and 1980s, there is likely to be support for an aggressive policy approach to stamping out inflation.
Higher energy prices are proving to be a major headwind to economic growth. Has this impacted your decision making? How or why not?
Most of the headline risk about energy prices focuses on the consumer impact – prices paid at the pump and higher utility heating bills but there are other considerations when analyzing the impact of higher energy prices.
Despite this universal headline risk, the impact is not the same in all economies – for example, economies that are more energy independent like Canada and the United States are impacted to a lesser degree by higher energy prices than those that rely on imported energy like Europe.
In Canada the energy sector represents about 10% of our GDP, so on balance higher oil and natural gas prices can be beneficial for Canadians because this acts as a tailwind for domestic economic growth. Higher energy prices translate into higher earnings and cash flow for energy companies which cycles back into the Canadian economy and helps with fiscal budgets. There are also second derivative impacts on the Canadian economy with sectors like industrial and financial services which also benefit from robust energy prices.
The energy sector represents about 18% of the S&P/TSX, so higher energy prices lead to outperformance of Canadian stocks compared with global benchmarks and that translates to increased foreign investment in our equities which boosts valuations. On balance, I think, higher energy prices are better for most Canadians despite the pinch at the pump or on the gas bill. It provides a nice tailwind for the Canadian economy which can lead to better earnings momentum and, in turn, greater optimism for Canadian stocks.
Europe is another story. In that region, a material spike in natural gas prices is proving to be a major headwind to economic growth. Europe doesn’t have energy independence, and so the region relies on the import of oil and gas from Russia. This has turned into a geopolitically driven and unpredictable path in pricing that has created a chaotic backdrop for energy prices.
In the short term there is very little that can be done to expand supply so the only way to bring prices down is to curtail demand. For businesses this means reducing production or manufacturing which has a very negative impact on the outlook for economic growth in the European economy. Consumer confidence has also been impacted materially because people are faced with much higher costs both at the pump and to heat their homes in the upcoming winter season. They also have fears of a gas shortage that may impact access to heat in the winter months.
Because the higher energy costs are contributing to very high inflation, the European central bank is also forced to increase interest rates in the face of a rapidly slowing economy which is exactly when you don’t want to be increasing interest rates. This makes us more negative on the outlook for Europe and leads us to favour North American investments where there is higher energy independence over Europe.
How is the global push towards decarbonization shaping your investment outlook across asset classes?
When we look at our investments across asset classes, part of our analysis is focused on how companies are planning to reduce their carbon footprint and how are they assessing the risks that come with transitioning to a low carbon economy. We assess companies in the context of their peers as a way to measure their potential for future return or required future investment to catch up if they are lagging.
We also look at the carbon footprint of our portfolios overall to understand the aggregate risk across a portfolio in addition to the individual company risk. We don’t believe that divestiture is the best path to achieve our collective goal of net zero. Instead, we partner with our investee companies through engagement and stewardship strategies that will help us achieve our long term goals of a reduced carbon footprint.