Global markets have stabilized over the past week after a challenging few weeks of trading.  While drawdowns are never welcome, we like to remind ourselves during these times that they are part of the reason that investment risk premiums exist – if there was no risk, there would be no potential reward as everything would be priced for perfection.  That said, we wanted to share our thoughts on the current market landscape, what drove the volatility and the potential paths forward from here.  

 

You'll find a link to this post by Avery Shenfield, CIBC’s Chief Economist. Fair warning: it’s about a 10-15 minute read and uses some economics jargon, so it’s not for everyone. But we think it’s important for you to know the firm’s outlook on inflation and growth as these two forces have been driving a lot of the market movements these past few months. Please bear with us for a few minutes while we try to sum up why we shared this article in the first place.

 

The volatility we’ve been seeing these past few months is largely because the market is recalibrating their expectations for growth and inflation, which feed into expectations around long-term borrowing rates. As we’ve discussed in past posts, borrowing rates have a huge influence on the value of all asset classes – bonds, real estate, stocks, private businesses, currencies and even commodities. One way of viewing the recent volatility in the market is as an expression of the debate about the path of growth and inflation going forward resulting from geopolitical events (the conflict in Ukraine and the lockdowns in China) and the coordinated increase in borrowing rates by global central banks (central banks trying to slow down the economy enough to tamp down inflation, but not too much to trigger a contraction in economic growth). Some view rates as moving much higher, and others view them as moving much lower. Until a consensus is built around where rates are heading, the push-pull between the two camps has created a lot of volatility. Thankfully, a consensus appears to be falling into place in recent weeks with long-term rates falling into the 2.75% - 3.00% range and short-term rates in the 2.5% - 2.7% range. But it’s early days.

 

By way of background, for the better part of the last decade, central banks like the U.S. Federal Reserve, the European Central Bank and the Bank of Japan have been trying to support growth and inflation by holding their benchmark borrowing rates at very low rates. They did so because they were concerned about the fallout from the popping of the U.S. housing bubble in 2006 – 2007 and ensuing financial crisis of 2008 – 2009 leading to a long period of deflation and a contraction in growth. Deflation is very hard to unwind and can be very bad for an economy. Japan is the cautionary tale, where aggressive increases in borrowing rates caused a real estate bubble to pop in the mid-1980s. What followed was 35 years where inflation hovered at around 1% and contributed to a lost generation of economic growth (Japan’s annualized GDP growth has averaged 0.2% since 1992). When consumers develop a mindset that they should save and not spend as they can buy something cheaper next year, deflation sets in and growth falters, forcing retailers to lower prices further to shed excess inventory, perpetuating the deflationary cycle.

 

On the flip side, keeping borrowing rates low for too long risks a repeat of the runaway inflation of the 1970s, which was equally painful. Many see echoes of the 1970s in the Ukraine crisis today as oil prices have skyrocketed just like they did during the Saudi and Iranian oil embargos of 1973 and 1979. What made the inflation worse during that time was the U.S. Federal Reserve held rates very low for too long and embedded the opposite expectation in consumers – that you had to buy now as prices might be much higher next year. This created huge wage inflation which depressed corporate profitability and led to high unemployment in the late 1970s and 1980s, which in turn depressed economic growth. It took two rates hikes of 10% (that’s not a typo) from 10% to 20% (again not a typo) and a recession (1983) to break the cycle. Needless to say, that is also not a desired outcome (many of our clients from that era remember mortgage rates in the 20% range …).

 

In short, global central banks are reacting to geopolitical events (Ukraine, Shanghai) and calibrating borrowing rates to create a “goldilocks” environment where inflation and growth are not too hot, and not too cold, but just right. These are the conditions that formed the backdrop for the steady economic growth of 2010 – 2020. As you can imagine, this is difficult to execute, and the market is second-guessing every one of their moves. Avery and the CIBC Economics team think they will pull it off again. We hope they’re right, but are prepared for the path forward if they aren’t.

 

Over the past few weeks, we have endeavoured to reach out to you to share our thoughts on the market volatility, how we have adjusted your investment portfolios at the margin to take advantage of it, and to see if anything has changed in your circumstances that might require an adjustment to your long-term plan.  If we have failed to connect or you’d like to set up a meeting for a more in depth discussion, please let us know.

 

Thanks again for your words of support, your transparency and your grace under pressure.  We’ll get through this together.

 

Back to our regularly scheduled programming next week.

 

 

 

 

 

 

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