Weekly Commentary
Market Recap
- Equity markets were modestly changed this week, despite plenty of volatility, including a strong (maybe curious) rally on the back of a speech from Fed Chair Powell.
- The S&P 500 rose 1.1% when all was done, while the TSX added 0.5%.
- Canadian bank earnings got underway to mixed results, and the sector lagged on the week, down 1.0%, although there were a few chunky dividend increases.
Dovish Fed Comments
Last week, markets surged on indications from the U.S. Federal Reserve that it is prepared to slow the pace of interest rate hikes. But was this reaction premature, and will it affect the Bank of Canada’s rate decision this week? Even before the Fed’s comments, markets’ expectation was that the next increase would be 50 basis points rather than 75. What the market was really happy to hear was that the terminal rate is unlikely to go higher than previously expected. That was a more dovish, or at least a less hawkish, statement than we’d heard previously from the Fed, and markets viewed it as something of a pivot, hence the positive reaction. Our evaluation, however, is that markets are still pricing in a rate cut sooner than we’re likely to get it. And they’re also underestimating how long we’ll stay at the terminal rate once we reach it. As for this week’s rate decision, the Bank of Canada doesn’t necessarily have to follow the Fed’s playbook—it’s entirely possible that we could see fewer rate hikes in Canada than in the United States, especially as the economy starts to weaken on the back of a weaker consumer. We do expect the Bank of Canada to continue to raise rates for now, but we don’t expect them to be as aggressive as they are south of the border.
Bottom Line: The Fed’s slightly dovish comments were good news for markets, but investors may still be underestimating how long higher rates will last—at least in the U.S.
China
After mass protests in China against the country’s zero-COVID policy, there are indications that the government may be ready to enter a new phase, loosening restrictions and allowing some virus-infected people to isolate at home. For Chinese stocks, this is good news—they’d already been on a tear recently on speculation that these strict policies could be relaxed, and now, it seems to be coming to pass. But the question remains—what will these new policies actually entail and when will the be fully implemented. On top of that, China is currently going through an outbreak, so it may not be an ideal time to introduce a looser policy. We do think that going forward, people will have to isolate for less time, which is a positive development. It will likely be Q2 or Q3 of 2023 before we see a full implementation of this policy and China returning to a more fully open economy. In anticipation of this rebound, we expect the outlook for Chinese stocks to be good over the next 12 months. But it could still be a bumpy ride if wider COVID outbreaks occur, which could dampen economic activity for one or two quarters.
Bottom Line: The loosening of COVID restrictions in China is a positive sign, but questions remain regarding of the implementation of new policies and the possibility of new outbreaks.
Canadian Banks
Canada’s Big 6 banks have reported their Q4 earnings, and it was a bit of a mixed bag, with half beating expectation and half falling short. These results reflect the overall state of the Canadian economy—not necessarily bad, but not firing on all cylinders either. (This is one of the reasons why the Bank of Canada may not follow the Fed’s lead, as mentioned earlier.) In general, the banks are still in good shape, though worries remain around loan loss provisions and the impact housing and higher mortgage rates may have on consumer sentiment. Trading activity has declined because of markets being down for most of the year. But as markets continue to rebound, the outlook for Canadian banks will likely be more positive going forward, especially as we approach the end of this interest rate cycle. If there was one surprise in this round of earnings, it’s that we did see most banks increase their dividends. That’s another positive sign, signaling that even if this quarter may not have been great, the banks aren’t too worried about outlook going forward and their balanced sheets look healthy.
Bottom Line: The Big 6 are in decent shape and appear to be taking a long-term view—as they should.
Positioning
As we head into the end of the year, our team’s evaluation is that we’re likely to see a continuation of the recent rally in equity markets, though at much slower pace. Given recent dovish statements, we don’t see any surprises coming from the Fed at their December meeting that would potentially cause markets to decline harshly. We do, however, think that markets are still a bit ahead of themselves, and that we could see some selling off of this rally as we get into 2023 and into the next quarter’s earnings season. Inflation is also a factor—if it stays relatively high, meaning above 5%, there could be a pullback in markets following the strong run-up we’ve seen in November and December. Fixed income, for its part, is continuing to look more and more attractive. For now, our positioning is still neutral, because we expect a few more interest rate hikes. But once we’ve seen one or two of those come through, we’re likely to move to slightly bullish. We also still have some cash, but it’s not because we don’t see opportunities—it’s because we want to hold some in reserve to capitalize on the pullback we may see in early 2023.
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