The Silver Lining of SVB

April 3 to 7, 2023

The Silver Lining of SVB

April 3 to 7, 2023

Commentary

Market Recap

  • Equity markets pushed higher again this week, finishing Q1 on a strong note.
  • The S&P 500 rose a snappy 3.5% on the week and, despite plenty of drama, closed the first quarter with a strong 7% advance. Meantime, the TSX added 3.1% on the week, which has allowed it to churn out a 3.7% gain in the quarter.
  • Oh, and the Nasdaq? Just a cool 16.8% rally in the first three months of the year, the best such run since January 2021.

Market Rally

A recent rally has driven the market higher than it was before Silicon Valley Bank (SVB) collapsed. On the surface, that’s a little puzzling, because there’s now more risk in markets. But what it highlights is that investors are more focused on the fact that economic uncertainty pulled down the interest rate forecast. Markets are already pricing in a softer economy and a potential recession. But what they really want is for rate hikes to stop. Once investors realized that a 6% terminal rate is now unlikely and 5% is perhaps back on the table, they reacted positively. Even the NASDAQ has done quite well—valuation concerns based on the trajectory of interest rates was what caused the damage last year. Now that rates aren’t as much of a concern going forward, we’re seeing a rally. On the one hand, it’s surprising. But on the other hand, it makes perfect sense, and it’s a good example of why we’ve remained balanced in our portfolios. All along, we thought we’d see a rally whenever the Fed decides to pause, and this is an indication of that expectation becoming reality. Looking ahead, we’re anticipating one more rate hike, and wouldn’t be shocked to see two. But the Fed has given themselves an out, commenting that the softening financial situation is similar in effect to a rate hike. It will all depend on the inflation number, however, so it’s still too early to know for sure.

Bottom Line: For markets, interest rates are the most important thing right now, and optimism on that front is what prompted the recent rally.

Federal Budget

Last week, the federal government unveiled its annual budget. It contained several new initiatives, including green incentives and the much-publicized grocery rebate. But there wasn’t anything that we’d consider a game-changer when it comes to our economic outlook for Canada. There is concern in some quarters about the deficit but, in our view, it’s all relative—just about every other developed economy is in the same boat. The deficit may put some pressure on the Canadian dollar but, beyond that, it’s unlikely to move markets. Looking at Canada’s economy more broadly, financial instability does increase the possibility of a soft landing relative to a best-case “no landing” scenario. Pressures from higher interest rates, higher mortgage costs and tightening consumer spending patterns also remain a concern. As a result, we still think being underweight Canada is the right call, even if gold, metals and oil prices could be a boost to the economy.

Bottom Line: There were no big surprises in the federal budget, and we’d expect its impact on markets and the Canadian economic outlook to be relatively muted.

Energy

Recent changes to how Brent crude oil prices are calculated have prompted questions about the forecast for oil prices and the Energy sector in general. We were somewhat surprised that oil prices came down as much as they did, the downturn being tied to heightened recession risks. We have seen something of a bounce-back since mid-March, and the re-opening of China will be a boost. But keep in mind that the re-opening is still at least a few months away. In 2021, we opened a position on Energy and saw it do extremely well in 2022 when it was the only port in a storm. Early this year we were selling calls against it to generate additional premium when we thought it might move more sideways. Now, we are in the midst of closing that position—we don’t see a special tailwind anymore, and as markets have gotten more bullish overall, other opportunities have presented themselves. Energy could still get a boost if the economy holds up better than expected, if China’s reopening goes particularly well, or if geopolitical risks flare up. But over the next three months or so, we don’t see anything that’s likely to push oil significant higher. As a result, it seemed like a prudent time to exit our position—we did very well and are happy to take our profits. Concurrently, we’ve increased our position in gold. It should serve as an effective hedge against reduced economic outlook and financial instability.

Bottom Line: We don’t expect a significant surge in oil prices in the near-term.

Positioning

In terms of positioning, one thing we’ll be watching closely is the movement in Growth and Value. We continue to believe that Quality is the best option. But earnings have started to bottom out and expectations are relatively low. If companies start to beat those lowered expectations and markets react positively, that could be a sign that it’s time to bring down our Value position and pivot to Growth, which we’ve already begun to do. On the bonds front, we expected a good bounce, and that’s exactly what’s happened. We’ve been very happy with our fixed income positioning—it has delivered a lot of value for clients. That’s because our forecasts have largely played out as expected, with the only hiccup being the financial fallout from SVB. A balanced approach has proven to be the right decision.

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