- Equity markets have rallied out of the gate in 2023, offering some hope that the dark days of 2022 are behind us from an asset price perspective.
- Recall that last year was historically bad for investors of most risk profiles. The S&P 500 fell more than 19%; 10-year Treasury total returns were -16.4%; and the combined 60/40 portfolio return of those two assets was the worst on a total return basis since at least 1970.
- We’ve simply never seen a year with both sides of the market down in sync like that, let alone punished so significantly.
The latest U.S. Consumer Price Index (CPI) numbers were released late last week, and they give us a few insights into the state of the economy and the trajectory of inflation. On a month-by-month basis, the numbers went down for headline CPI and slightly up for Core but year-over-year, both went down. Market response was nothing out of the ordinary and as the week concluded the markets even rallied further. This implies that investors still believe the U.S. Federal Reserve (Fed) is near the end of its rate hikes. Overall, the numbers suggest that the Fed will continue on its current trajectory, slowing rate hikes until a plateau is reached. We’re not there yet, but we’re definitely closer to the end of the rate hike cycle. Although a soft landing remains the most likely outcome, our evaluation is that the Fed is unlikely to cut rates in 2023. Once the rate increases stop, the Fed is likely to give them at least six months to see what kind of impact they’re having. Currently, the job market is very good, and even if it declines to merely good, that’s not the kind of troubling economic environment that would prompt the Fed to cut rates prematurely and risk an inflation rebound. In Canada, the situation is somewhat different, as the economy is more driven by the consumer. This could lead the Bank of Canada to cut rates before their U.S. counterparts. But that’s still unlikely to happen before late 2023.
Bottom Line: CPI numbers suggest that the Fed will stay on course, with rate cuts unlikely in 2023, while Canada could cut sooner.
Recent layoffs in the Tech sector, including at big names like Tesla and Netflix, are making headlines. But is the worst behind us? Unfortunately, we think the answer is no—more pain likely lies ahead. The initial round of layoffs were from the largest companies, then we saw them in some of younger companies whose growth is out in the future given the economic environment has changed so much. But those layoffs have now spread like a contagion to other Tech sub-sectors. The silver lining, if there is one, is that since Tech was the first sector to be hit by job losses, it will also likely be the first to recover. In terms of positioning, we’re still neutral on Tech and underweight Growth, though that can largely be chalked up to our negative view of low-quality Growth. We’re still slightly bullish on Quality Growth, and we’re continuing to examine valuations to see if opportunities emerge in the not-too-distant future. There is no doubt that valuations are looking for attractive and some times you can’t wait for the exact bottom to buy in.
Bottom Line: More tech layoffs—and potentially layoffs in other sectors—are likely on the horizon.
The Financials sector is often considered something of a bellwether of the economy, and in general, it’s holding up relatively well. The start to the year has been fairly strong, and recent earnings announcements from heavyweights like J.P. Morgan, Bank of America and Citigroup were positive lifting both stocks, though Wells Fargo did disappoint but that seems more like a company specific situation than the broader industry. The consensus at the moment is that the consumer is fairly strong—unless there are significant unexpected job losses, they’re likely to continue their current spending patterns, perhaps shifting somewhat from Consumer Discretionary to Consumer Staples as the economy slides toward a recession. And the U.S. dollar also remains relatively strong. Trading income is one potential area of concern for the investment banks. But it was already down in 2022, so the year-over-year decrease shouldn’t be too worrisome.
Bottom Line: Financials seem to be doing well, and while earnings will give us further insights into the state of the economy, we don’t expect any major surprises.
We’re remaining neutral on our equity/bond mix. The end of the interest rate hiking cycle is in sight, which is cause for optimism, but that could be offset by a worsening economic environment in coming quarters. With that uncertainty in mind, a balanced position makes sense. We’re slightly overweight fixed income and slightly underweight cash. Compared to GICs, investors are now getting a strong yield out of the bond space, as well as upside potential. But at this point, we prefer Investment Grade bonds over High Yield or Emerging Market Debt. Geographically, we now prefer the U.S. over Canada, as we’re neutral on the former and slightly underweight the latter. We believe that markets will become less risk averse, and that kind of environment will favour U.S. equities. Internationally (EAFE), we are back to neutral from our previous underweight. Better weather has helped improve the energy situation for international markets, and a lot of the negatives have already been priced in. We remain slightly overweight Emerging Markets based on the reopening of China, which we think will be a good news story in 2023 despite some likely ups and downs. And finally, we’ve recently sold some Energy calls 3-5% out of the money, which allows us to participate on the upside while generating premium income. The overweight in energy in 2022 was a big winner.
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