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THIS WEEK WITH SADIQ

The Consumer Snowball Effect

October 3 to 6, 2023

THIS WEEK WITH SADIQ

The Consumer Snowball Effect

October 3 to 6, 2023

Commentary

Market Recap

  • Equity markets struggled this week as bond yields continued to push higher and test valuations.
  • The S&P 500 fell 0.7%, with utilities down sharply, while consumer stocks and financials also struggled. Ten-year Treasury yields continued to rise on the week, as did most of the yield curve, before backing off somewhat on Friday. That despite some sluggish data and a well-behaved ‘supercore’ inflation print, which rose just 1.7% annualized in August, or 3.4% over the latest three months.
  • Meantime, the TSX fell 1.2% as rate-sensitives and higher-yielding sectors struggled alongside new highs for GoC yields—as one example, the closely-watched 5-year yield pushed to 16-year highs.

China

A crisis in the Chinese property sector has been brewing for some time, and last week brought more stunning developments, as real estate giant Evergrande’s shares were suspended in Hong Kong on news that the company’s director and chairman, Hui Ka Yan, is suspected of “illegal crimes.”1 The property sector in China continues to have issues across the board. It will take quite some time for consumer confidence to return, and the problem is compounded by the fact that housing is by far China’s most important market. If it doesn’t stabilize, it will be difficult to imagine people having the confidence to invest, putting a cloud over the economy’s reopening and negatively impacting its growth prospects. In our view, weakness in the property sector is a key reason why we haven’t seen China’s economy bounce back as strongly as many had expected, with generally poor consumer confidence and a lack of government stimulus also playing a role. Going forward, the reopening will continue, but it’s unlikely to reach the level we experienced on this side of the Pacific—North America didn’t have to contend with both post-COVID challenges and a property crisis at the same time.

Bottom Line: Some kind of economic resurgence in China is still likely, but it may not reach pre-COVID levels anytime soon.

Consumers

Recent numbers from the Conference Board, amongst others, shows that consumer confidence is waning in North America. This is how we’ve been expecting things to go. At the beginning of the year, expectations for the consumer were relatively low. But then around July, there was a realization that the consumer was actually holding on quite well, and expectations were revised upward. We believed that consumers were strong, but also that at some point in time, the impact of higher interest rates would have to kick in. That’s exactly what we’re seeing now—a gradual decline in the consumer. We expect it to be like a snowball rolling downhill: slow at first, but picking up speed over time. The question is—by the time it really gets rolling and consumers are feeling the pain, will governments and central banks have stepped in to stimulate the economy by, for instance, cutting interest rates? That’s a question for 2024. For now, higher oil prices, high interest rates, and a weak September for markets are all taking their toll, and the housing market also hasn’t bounced back the way people were expecting. Together, that’s a recipe for declining consumer confidence.

Bottom Line: We expect a slow, gradual decline of consumer strength in the coming months.

U.S. Government Shutdown

The Sunday morning deadline for the U.S. congress to pass a government funding bill has come and gone, and thanks to a last-minute deal, a shutdown was averted. This playbook has been repeated many times, most recently with the debt ceiling crisis: delays and delays, a bit of political grandstanding, then finally a deal. This agreement is only temporary, so the scenario could play out again in November. In general, however, this is not the kind of situation that will affect our portfolio positioning, as these crises are typically resolved before they can have a significant effect on GDP or the broader economy. That said, the larger issue is one of consumer confidence—higher for longer interest rates and above-average inflation, as well as the ongoing United Auto Workers (UAW) strike, could accelerate a slowdown in spending, and those impacts could begin to appear in the next one or two quarters. In our view, the UAW strike is more concerning than the political brinksmanship over a shutdown; it could last for some time, will have far-reaching implications for the Automotives sector, and could also have knock-on effects for other sectors. It’s entirely possible that labour groups in other industries may see this job action as a model, causing other potential production issues down the road.

Bottom Line: A short-term U.S. government shutdown would be unlikely to have a material impact on economic growth, but the UAW strike is a situation worth monitoring.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Sidestepping Cracks in Uncertain Markets.

Disclosures:

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.


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