Tuesday 09/27/2022

  • Stocks find some temporary footing but struggle to hold on – After moving sharply higher in early trading, equities lost their momentum as the day went on, with the Dow and S&P 500 closing slightly lower on Tuesday. There were no major headlines behind the move. Instead, we think this reflects the current phase in which investors are attempting to digest a balance between ongoing positives in the economy and the Fed's recent announcement around further sizable rate hikes. Though the major averages failed to hold on to early gains, small-cap stocks finished higher on the day1, alongside outperformance from the consumer discretionary, technology and energy sectors, signaling a more optimistic cyclical undertone within today's move. The TSX received some help from a gain in crude oil prices on the day. It's too early to declare that the latest bout of volatility has fully run its course, but we think Tuesday's move showed some signs of stabilization after the stock market's multi-day slide, suggesting the revised expectations for more aggressive Fed tightening this year have been more fully priced into stocks and bonds.
  • Spotlight remains on the move in interest rates - Short-term rates were little changed today. And with 2-year yields surging recently to reflect a tighter policy stance from the Fed, the pause today reflects ongoing adjustments to expectations for upcoming Fed rate hikes. At the same time, the yield curve steepened today, as 10-year Government of Canada bond yields and U.S. Treasury yields moved up again, which is consistent with better sentiment around the economic outlook.  Yields have risen to the highest levels in more than a decade following the Fed's commentary on its plan to keep rates higher for longer amid its battle with inflation.  Incoming inflation data will serve as the primary guide for interest rate moves in the coming months, but we believe the recent jump in rates largely reflects much, if not all, of the policy rate hikes the Fed will pursue over the balance of the year. Domestic long-term rates have risen less than in the U.S. recently, reflecting a weaker labour market and a lower-than-expected inflation reading last month. So while the bond market has suffered this year under the weight of rising rates, we believe the bulk of the move higher is behind us. Historically, when interest rates peak, bonds have delivered healthy returns over the following year.
  • Positive news on the economy – While recession risks have risen appreciably on the back of central banks' more restrictive approach, data out today offered evidence that the economy is showing some resiliency.  The domestic calendar is light, but August U.S. durable goods orders (excluding defense and aircraft orders) rose by a very strong 1.3% versus the prior month, indicating that business investment in equipment continues to hold up despite monetary-policy headwinds. Though aggregate demand is slowing, it's coming down from elevated levels, meaning businesses are still seeing opportunities to invest for a broader economic expansion. It's likely that durable goods orders will slow from August's lofty growth as broader conditions continue to weaken. But with sentiment currently quite pessimistic, we think this latest read on business investment is an encouraging sign that the economy is not destined for a deep or prolonged recession.

Craig Fehr, CFA
Investment Strategist

Source: 1. FactSet, measured by the Russell 2000 Index


Monday, 09/26/2022

  • Markets fall for the fifth straight session: Markets fell again today after Friday's sell-off, as rising interest-rate worries take hold. Rising Treasury yields and a persistently inverted yield curve are putting more credibility behind the bear/recession case. Investors are worried that the Federal Reserve will be too heavy handed and turn economic growth negative with its aggressive rate-hiking cycle and now forecast 4% terminal rate. The 2-year and 10-year Treasury yields topped 4.3% and 3.7% respectively, a 70-basis point inversion. The U.S. dollar surged in strength over the weekend after the pound sterling fell to historically weak levels. A strong dollar has typically led to global financial pain. The price of oil continued to slide as recessionary fears put downward pressure on demand forecasts, with the WTI trading around $77/barrel and Brent crude falling below $85. Natural gas has also fallen sharply from $10 earlier in the year to around $7 today, a nearly 30% drop.
  • A strengthening dollar and weakening pound: The pound sterling fell sharply on Friday and over the weekend after the U.K. government announced a fiscal stimulus plan that included tax cuts and additional spending at the same time as the central bank tries to tame inflation through rate hikes. The pound is trading around 1 to $1.08 U.S. dollars. The fall in relative value likely adds to inflationary pressures, as imported goods become more expensive in pound relative terms almost overnight. Policymakers and economists in the U.K. are calling for the central bank to make an emergency interest-rate hike to arrest the fall in value of the U.K. currency. Conflicting fiscal and monetary policy typically leads to uncertain outcomes, and it's hard to predict what effect it will have on the economy. Prices in Europe (including the U.K.) have already surged this year, and many economists are forecasting an almost certain recession in the region. Prices were rising before the invasion of Ukraine, but the conflict with Russia has led to lower levels of supply in natural gas from Russia to the rest of Europe, driving up prices and prompting the government to consider natural gas rationing. We think it will be difficult for the region to avoid a recession this year, and the lack of a reliable energy supply will exacerbate softness in economic growth.
  • Path of least resistance still lower for risk assets: Asset values across the board are lower, from bonds to bitcoin, as investors shun risk assets and move to safe-haven investments like the U.S. dollar. Emerging markets have been underperforming U.S. equity markets in recent weeks, as investors price in lower demand for commodities (which emerging markets rely on as a major source of income). International developed equity-market performance has also been mixed, with the Canadian TSX and European indexes much lower than the S&P 500. In Asia, markets are also lower, but China has moved to an expansionary monetary policy to try to stimulate economic growth, as COVID-19 lockdowns have put pressure on manufacturing capacity. Technology shares have been some of the hardest hit stocks with their acute exposure to interest rates, as they rely more heavily on cheap debt to fuel profit and revenue growth. Higher rates are also a drag on valuations, and growth/tech stocks have had some of the highest valuations in the market. We expect volatility to continue until inflation has a meaningful move lower and the Fed can pause its aggressive interest-rate hike path.

Sloane Marshall, CFA
Associate Analyst

Source: FactSet

This chart shows the recent drop in the value of the Pound Sterling relative to the U.S. dollar after the government announced a fiscal stimulus plan. The Pound is trading around $1.08.


Friday, 09/23/2022

  • Surge in global yields drive stock rout - Market anxiety remained high as investors continue to process implications of a week of worldwide central-bank tightening and rising bond yields that are pressuring valuations. The S&P 500 retested its June low, the TSX declined the most in three months, and European stocks were sharply lower after weak eurozone data and a new economic plan from the U.K. that added to inflation concerns. In Canada, retail sales came in weaker than expected, declining 2.5% in July, driven by a decline in gasoline sales and softness in other categories. However, the preliminary estimate for August was more encouraging, pointing to a modest 0.4% rise. Energy stocks led the losses, as oil declined 5.5% and dropped below $80 a barrel. The loonie fell to two-year lows against the U.S. dollar, weighed by the risk-off sentiment and this week's rise in U.S. yields.
  • Global policy tightening remains in focus - Interest rate hikes across the U.S., U.K., Sweden, and Norway this week brought into renewed focus the challenge aggressive policy tightening poses on global growth and equity valuations. Leading the charge, the Fed delivered another three-quarter-point rate hike on Wednesday, its third in a row, raising the fed funds rate to a range of 3.0%-3.25%, as expected. The rate hike was accompanied with projections for more hikes, confirming the Fed's determination to tame the highest inflation in decades. The Fed's steeper rate path, together with actions from other central banks and today's news on U.K.'s new economic plan, continued to push bond yields higher. The policy-sensitive U.S. 2-year Treasury yield rose to 4.19%, a 15-year high, while the more sensitive to economic growth 10-year Treasury yield declined slightly to 3.68%, still the highest in a decade*. In Canada, both short- and long-term yields were lower today, likely reflecting the weaker economic data that could persuade the BoC to slow its pace of tightening. The recent jump in global yields will likely weigh on economic growth in the quarters ahead, but we think we are closer to the end than the beginning of the central banks' tightening campaign.
  • Depressed sentiment could help stem further declines - Friday closes another losing week, with the S&P 500 down about 23% this year, the TSX down 13%, and investment-grade bonds down 14%. Heading into the last quarter of the year, we think that inflation will be the No. 1 driver that will determine the direction of travel for the markets.  Until a pattern of lower inflation readings is established (likely three or more needed), equities are likely going to have a hard time mounting a sustainable rebound, and bonds could remain under pressure. A focus on quality and defensive positioning is warranted in the short term, in our view, as the central-bank tightening will continue to pose a strong headwind to growth. But with equity-market valuations having come down about 26%, rate expectations repriced higher, and with a sizable amount of recession fear priced in, we are likely closer to a bottoming process today. Investor sentiment is very depressed, with flow data pointing to extreme pessimism (the worst since the Global Financial Crisis), which historically tends to be a contrarian buy indicator.

After a busy week of central-bank meetings, the market’s attention next week will shift to the strength of the economy. Key macroeconomic releases in the U.S. include durable goods orders, consumer confidence, and personal income and spending data. The July GDP will be the main focus in Canada.

*Source: Bloomberg

Angelo Kourkafas, CFA
Investment Strategist


Thursday, 09/22/2022

  • Markets search for footing amid a higher-for-longer rate outlook – Canadian and U.S. equities oscillated around the flat line for much of the day Thursday before losing some steam late, finishing modestly to the downside, as stocks were unable to build a firm toehold following Wednesday's Fed-induced dip. Defensive areas like health care, utilities and consumer staples led today, while small-cap equities lagged, reflecting an ongoing tone of caution as investors digest the latest Fed news. Interest-rate hikes remain front and center, with Government of Canada bond yields and U.S. Treasury yields moving higher in anticipation of a more aggressive tightening campaign from the Fed to fight inflation. Overall, we doubt volatility stemming from rate-hike and recession worries will disappear quickly, but the emergence of some stabilization in stocks after the pullback in recent weeks would be an encouraging sign that markets are recognizing the existing balance of both headwinds and areas of fundamental support that we believe remain in place.
  • Digesting central-bank policy – Elevated inflation and the resulting policy response from the U.S. Fed will remain firmly in the driver's seat for the stock and bond markets as we advance. The Fed's 0.75% rate hike announcement on Wednesday came as no surprise, but its outlook for the size and duration of further rate hikes sapped investor sentiment and reignited concerns over a Fed-induced recession. Global central banks joined the parade on Thursday, brightening the spotlight on monetary-policy actions and implications for economic activity around the world. The Bank of England, Swiss National Bank and Norway's central bank all hiked rates, consistent with the coordinated policy response to address inflation pressures across most of the developed world. We expect the Bank of Canada and U.S. Fed to remain committed to bringing down inflation, and Wednesday's U.S. rate announcement indicated that the FOMC is willing to incite some near-term weakness in the economy in order to achieve a downward path for consumer prices. This is the prudent approach, in our view, as increasingly entrenched inflation would present more severe long-term challenges for the economy and financial markets.
  • A broader view offers a more positive outlook – While rate-hike headwinds have driven weakness in the stock market of late, we think there are several reasons investors can be positive:
    • U.S. initial jobless claims, out on Thursday, came in at a better-than-expected 213,000. Jobless claims remain at very low levels, indicating that the labour market continues to hold up quite well.
    • Corporate earnings have remained fairly resilient in the face of policy headwinds and rising input costs. Corporate profits tend to be a powerful guide for broader market performance, and S&P 500 earnings are still expected to rise at a reasonable pace over the coming year,
    • Stocks have given back a bulk of their summer rally but remain above the June lows. Market declines are never comfortable, but we think the greater-than-20% decline already reflects a lot of the bad news and pessimism, suggesting to us that much of the pain has already been endured.  We think the broader-term upside outweighs potential near-term volatility, with markets likely to mount a more sustained rally as the Fed eventually finds an opportunity to dial back policy tightening. Thus, the current pullback offers a compelling longer-term buying opportunity, in our view.

*Source: Bloomberg

Craig Fehr, CFA
Investment Strategist


Wednesday, 09/21/2022

  • Markets end lower in response to a hawkish Fed - Stocks swung between gains and losses but finished lower in response to the Fed's hawkish projections. The steeper rate path than the one officials projected in June, highlights the Fed’s resolve to cool inflation and likely means further tightening in financial conditions, slower economic growth, and higher unemployment. Despite the renewed pressure in financial markets and the economy that the Fed's path implies, the decline in stocks and rise in bond yields experienced this year already largely reflects this challenging backdrop, in our view. Also souring sentiment, geopolitical tensions remain high amid headlines that Putin will mobilize army reserves to support the Ukraine invasion. Short-term bond yields rose, while the 10-year yield declined likely signaling more economic uncertainty ahead.
  • Fed signals higher-for-longer rates policy - The Fed delivered another three-quarter point rate hike, its third in a row, raising the fed funds rates to a range of 3.0%-3.25%, as expected. The September hike pushes the policy rate into restrictive territory, above the 2.5% rate that policymakers consider neutral (neither stimulating nor constraining the economy), as the Fed wages its most aggressive fight against inflation in four decades. Along with its policy rate, the Fed released its updated economic projections which showed another 1.00% - 1.25% of rate hikes this year (possibly 0.75% in November and 0.5% in December), and rates peaking at 4.6% in 2023. Officials also revised their forecasts for growth lower and for unemployment higher as the economy is projected to slow further in response to the tightening of financial conditions.
  • Volatility likely to stay elevated until inflation peak is confirmed - Heading into the last quarter of the year we think that inflation will be the number one driver that will determine the direction of travel for the markets. Until a pattern of lower inflation readings is established (likely three or more needed), equities are going to have a hard time mounting a sustainable rebound. While the August CPI data move us a bit further away from the best-case scenario, it does not necessarily change the likelihood that the rate of inflation will slow in the coming months, driven by improved supply-and-demand dynamics. With the Fed firmly on the brakes and growth slowing, the macroeconomic backdrop remains challenging, requiring patience from investors. Markets might stay rangebound for a while but should eventually start recovering as central banks become less hawkish.

Angelo Kourkafas, CFA
Investment Strategist


Tuesday, 09/20/2022

  • Stocks finished lower ahead of the Fed: Markets continue to be hyper-focused on Federal Reserve policy, trading lower today. Growth and value performed similarly as sentiment soured. The U.S. 10-year yield has passed 3.5%, in anticipation of higher Fed interest rates, while the 2-year yield has reached a new 15-year high. The 10-year minus 2-year yield curve is still firmly inverted, as bond investors expect aggressive Fed policy to tip the U.S. economy into a recession. Oil prices have stayed range-bound between $80 and $90 and traded around $86 today, while natural gas has fallen from a recent high of over $10/million BTUs to around $7.7 today. On the international front, European shares weakened while Asian stocks traded higher. The dollar was mixed against a basket of currencies.
  • Investors are divesting risk assets: Cryptocurrency performance today and over the course of this year has highlighted the move from risk assets towards safe-haven assets, like the U.S. dollar, amid growing recessionary and geopolitical risks. The recent move to regulate cryptocurrencies might certainly be playing into the drop as well, but bitcoin and other cryptocurrencies such as ethereum have been falling throughout the year, well before any regulation. Investors will generally move into safe-haven assets if the outlook for the economy in the short to medium term is unfavorable. Investors are concerned that the Fed's response to high inflationary levels will tip the economy into a recession and put pressure on asset prices. Central banks around the world are following the Fed and raising rates in their respective countries, including in Europe, where high gas prices and shortages are expected to be a catalyst for recession heading into the winter season.
  • August housing starts beat expectations, but building permits slow: Housing demand has fallen sharply in recent months, as higher interest rates hit consumers and price-out potential buyers. Thus, reports have started to trickle in showing builders have been forced to lower prices even as cost inputs have risen and builder sentiment has been falling. In August, housing starts rose unexpectedly, but housing permits fell by more than 10%. Housing permits are seen as a leading indicator for housing activity, and the drop points to further slowing in the sector. Housing was one of the biggest winners from the pandemic, as prices rose sharply on high demand and low interest rates.

Sloane Marshall, CFA
Associate Analyst


Monday, 09/19/2022

  • Markets start the week higher: Equity markets in the U.S. and Canada rebounded late in the day, with major equity indexes ending in the green. This comes after the S&P 500 fell nearly 6% last week, bringing year-to-date returns down to about -18%, close to bear-market territory once again. Today's volatility was sparked in part by a move higher in bond yields. The 10-year U.S. Treasury yield moved higher by 0.04% to 3.49% levels, getting closer to the highs of the year around 3.50%, which were set in mid-June. Meanwhile, 2-year yields moved higher by 0.09% to 3.94% levels, further exacerbating the negative yield curve, with the 10-year to 2-year curve inversion now near a high of -0.45%*. Historically, inverted yield curves tend to be a signal of a downturn or recession pending, although they have a lag time of six to 18 months. Energy prices also stabilized today, with WTI crude oil prices flat around $85 levels. The move lower in recent days reflects growing concerns around a slowdown in global growth and weaker demand for commodities.
  • Higher yields putting pressure on equity markets: Treasury bond yields have continued to push higher, especially after last week's hot inflation reading sparked market expectations that the Fed would be more aggressive in its rate-hiking cycle. We have seen yields globally across the curve push to their highs of the year, reflecting higher interest-rate policies across global central banks. This move higher in yields tends to put downward pressure on equity-market valuations, as the discount rate for future cash flows is higher. This particularly impacts growth sectors, more speculative parts of the market, and longer-duration assets, all of which expect cash flows in the later years in their business models. In our view, yields may continue to grind higher until a couple months prior to a pause in rate-hiking, which may occur around the start of the new year. In this backdrop, we would expect ongoing market volatility in the near term, but perhaps followed by a period of stability and recovery heading into year-end – particularly if the move higher in yields abates.
  • All eyes on the Federal Reserve on Wednesday:  The FOMC will meet on Tuesday and Wednesday this week and will release its interest-rate decision as well as an updated summary of economic forecasts on Wednesday at 2:00 p.m. EST. In our view, the Fed is likely to raise rates by 0.75% to bring the fed funds rate close to 3.25%, which most consider restrictive monetary policy. Given the recent higher-than-expected inflation reading, most investors expect the Fed's tone to remain hawkish and vigilant, reiterating its primary focus on bringing down inflation. However, with equity markets falling sharply ahead of this week's meeting, some of this hawkish message may be getting priced-in already. We will also be watching for the Fed's new "dot plot," which may show that FOMC participants expect the terminal fed funds rate for this cycle to be as high as 4.5% or 4.75%. In our view, the Fed and markets are getting closer together on interest-rate expectations, and the Fed may choose to pause rate hikes by early 2023 to assess the impact of higher rates, which tend to have a lag impact on the real economy.

Mona Mahajan
Investment Strategist

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