Third quarter 2022: Previous bear markets have a keen understudy.
For the Quarter
The previous quarter’s trends continued in the same direction this past quarter; at the end of September, the bond and stock markets remained on pace to challenge some of the worst returns on record as measured by Bloomberg and Factset.1 The U.S. Federal Reserve (Fed) continued to openly state its intentions for higher rates both by jawboning and via the media and public appearances. This is continuing as we write this in early October. Most central banks around the world, including our own, are in lockstep, although the U.K. did stutter a bit recently.
The rate of change and the amounts of rate hikes are still being signalled, and parts of the economy are now definitely showing signs of the tighter policy. One example is our local housing market. According to recent September 2022 statistics, sales volume was down 42.6% versus the previous year with prices off only marginally. Year-to-date activity was down 27.3%, but prices still were holding double-digit gains.2 At this point, higher rates are having an effect in volumes if not prices.
Sentiment is still showing in extremely negative numbers. As also highlighted in the second-quarter letter, levels like the current readings often spark violent rallies or signal a change in trend. This has happened in the past and will most likely do so again. In fact, there was a 20%+ rally in the S&P 500 Index from late June until August of this year. In bear markets there are often multiple failed rallies until the ultimate low is hit. Extreme sentiment levels signal bottoms, but not always “The Bottom.” They are part of the process and, as such, should be taken into account along with other factors.3
At the end of September, the TSX was off -2.21% for the quarter and -13.09% for the year. The S&P 500 was off -6.27% (-24.77% YTD) and Nasdaq was down -4.96% (-32.40% year to date.). Gold is still not acting as an inflation hedge and is now down -8.4% for the year, after dropping another -7.06% for the quarter. Oil held on to positive year-to-date results at 5.51%, roundtripping from the $130 levels back to the $70 levels. For the TSX, sectors with positive returns year to date remained the energy complex, fertilizers, diversified metals and consumer staples. Utilities were bumped out of the green as they most likely started to feel the competition from interest rates.1
The U.S. dollar continued to benefit from higher rates and perceived stability, climbing 7.4% versus the Canadian dollar in the quarter. In times of turmoil, the U.S. dollar proves yet again to be the destination for capital from all over the globe.1
Savers are finally receiving something for their trouble, as yields, both short and long, have moved up. Although inflation is still printing in the 8%+ range as this is written, a bond or GIC in the 5% vicinity is available. The money that was printed over the past few years is now being taken into account. Thirty-year fixed mortgage rates in the U.S. are now pushing 7%, and the cost of home ownership has gone up accordingly. In Canada, those with variable-rate mortgages will no doubt notice the effect of a doubling in the rates from the offerings of last year.1
Central bankers have telegraphed their desire to stop inflation. They need to see a slowdown in the economy and the other signs of what was once defined as a recession. No doubt some of these metrics are now visible. The latest popular saying is “hopefully they don’t break something,” referring to the financial sector and the economy, in general. History has shown that it is pretty hard to stick a soft landing while combatting inflation form the current levels.
What ducks have to line up for a positive shift going forward? First, and most likely foremost, is a change in tone from central banks from hawkish to dovish. Recently we have heard that other birds like pigeons might be more appropriate. Many do think the Fed is …for the birds! A change in fiscal policy, a.k.a. responsible spending, could perhaps also help. Of course, the end to a war and an overall improvement in the current geopolitical situation would be of assistance, as well.
Will the banks lighten up on the brakes? It will happen (we just don’t know when), but when it does the markets will react and, again with history as a guide, it should be positive.
From the Darkness Arises…
The above chart, courtesy of Goldman Sachs, provides some light at the end of the tunnel. It puts the current environment into perspective. Throughout history, bear markets are followed by bull markets, and the cycle goes on as long as there are financial markets and humans interacting with them. The current declines set us up for future advances, although no one can predict the timing of the upward trend.
Dislocations and disruptions in the present provide the opportunities of the future. This movie has been played before and many of us have witnessed the previous renditions, lived through them and prospered.
As always, if you have any questions or concerns feel free to contact us.
All the best!
1 Source for market data: Thomson Revinitiv, Bloomberg, Factset
2 Source: CREA and the London St Thomas Association of Realtors (LSTAR)
3 Source: Sentimentrader