- Markets continued to struggle across the spectrum this week under the weight of inflation and central bank tightening prospects, but rallied late on chatter about an eventual pause by some Fed officials.
- The S&P 500 rose 4.7% after a sharp Friday rally, while the TSX was up 2.9%.
Recent comments by U.S. Federal Reserve governors seem to be lowering expectations for future rate hikes. This indicates the Fed’s belief that we’ve reached peak inflation, and we share that view for several reasons. Rising prices for products like food and cars have started to cool on a year-over-year and month-over-month basis. The one sector that’s heading in the opposite direction is Energy. But generally, the Fed appears to have had some success at controlling the demand side of inflation. It takes time for interest rate increases to have their intended effect—we’re already seeing some evidence of demand slowing down, and we expect that to continue. On the other side of the equation, supply chains do appear to be improving, which will help moderate prices further. But we wouldn’t expect the target inflation of 2-3% to be reached by the end of the year. What the Fed wants to see is evidence that enough headway has been made against inflation to stop the 50- and 75-basis-point rate hikes and get back to more conventional 25-point increases. Our view is that the rate hike expectations haven’t really changed, but now, there is an end it sight.
Bottom Line: We’re likely reached peak inflation, but it’s unlikely that the Fed will change its aggressive stance before the first quarter of 2023.
Bottom Line: A recession is on the horizon, but it’s too early to know how long and deep it will be.
Speaking of recession, banks appear to be preparing for one by increasing their loan loss provisions. This typically indicates that the consumer is getting weaker. That’s no surprise, but it is nice to receive some measure of confirmation from the banks. This negative outlook was evident in incredibly bearish comments made recently by JPMorgan Chase CEO Jamie Dimon. Banks generally have excellent insights on consumers because consumers invest in many different parts of their business, so their outlook is worth listening to. But perhaps counterintuitively, U.S. bank earnings were very strong this quarter. We’ll be paying attention to future quarters to see if loan loss provisions go up or get released. Dividends seem to be very secure, especially those of Canadian banks. And if stock prices drop, yields will go up, which provides a bit of a buffer—if you’re getting 5% yield, for instance, that gives you 5% downside protection before your total return is negative.
Bottom Line: We favour Energy and Tech over Financials, but we do expect banks to outperform the broader market.
In terms of positioning, we haven’t made any major changes recently. We continue to ask ourselves the question—is it time to buy? But the answer remains no. If anything, we’ve concluded that if equity markets rally, the best course may be to take some more risk off the table. We’re still not convinced that negativity in earnings and consumer confidence is priced in yet, meaning that markets could move another leg lower. And we also expect inflation to remain relatively hot—even if we have reached its peak—which will continue to erode consumers’ purchasing power. On the fixed income side, we’re now neutral on bonds after several quarters of being bearish, and we’re not far from having a slightly bullish outlook.
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