- Equity markets pulled back this week, alongside sticky inflation and a shift in expectations toward more Fed rate hikes.
- The S&P 500 fell 0.3%, with energy deep in the red.
- The TSX dipped 0.5% despite a surge in health care.
Last week, yields on six-month U.S. Treasuries topped 5% for the first time in over 15 years. What does that say about the market’s expectations? First, it’s an indication that investors think inflation will be sticky and not necessarily come down in a straight line. The easy part of tackling inflation is over; the hard part—the stickier stuff—is what remains, and that needs to be priced in. We expect central banks to remain aggressive, and markets are increasingly sharing this view, with evidence that the U.S. Federal Reserve could hike rates more than a couple of times in the coming months. This development also shows that the economic environment has changed. Not so long ago, many investors were expecting an interest rate plateau and potentially even rate cuts sooner rather than later. We thought this was overly optimistic, and we’ve proven to be correct. The economy has held up better than expected, and as a result, a potential recession has been pushed further out, meaning fewer job losses than expected and less of a reason to cut rates this year. For months, the two camps in the recession debate have been soft landing vs. hard landing. Now, there’s a third option: no landing. The market seems to be exactly attuned to the Fed’s expectations, and that doesn’t happen often.
Bottom Line: The market’s expectations have shifted, and a recession now looks less likely.
Bottom Line: The overall job market remains relatively strong despite much-publicized layoffs.
Sentiment vs. Reality
Bottom Line: Investors say they’re nervous, but their actions tell a different story.
When we evaluate our positions, we think about short- and long-term outlooks. Energy is a great example. In the short-term, we expect a sideways market or slight movement lower. That’s a good time to sell calls to generate additional income, which we’ve been doing. But in the long term, the benefits of China reopening and demand outweighing supply should boost energy prices. Plus, energy companies—which is what we’re really invested in—are profitable and have access to cash, which should help on the earnings side. And those companies remain under-invested in, so there’s the potential for more investment to push prices upward. Taking a step back, it’s still a choppy market—we’ve seen that in February so far. That’s why we continue to utilize a ‘collar strategy’ in our portfolios, in which we sell calls and buy puts. We aren’t expecting a smooth ride—economic data, Fed comments, earnings numbers, and other factors all have the potential to upset the applecart. In that kind of environment, we want to make sure we have the protection of options in our portfolios, and we’re willing to trade off some upside to do so.
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