Stock markets have managed to move ahead moderately this year but appear largely stuck in a narrow trading range with only a handful of companies really powering the gains.
While we’re pleased to see the TSX and S&P 500 are both up moderately since the start of the year, significant concerns remain. Currently, we’re expecting volatility more banking failures (definitely likely), the probability of a recession in the second half of the year, in addition to a magnitude of geopolitical concerns stemming from the war in Ukraine.
With all the worry, one might wonder why markets are up at all? It would appear that investors have little choice but to continue to ride the volatility due to a lack of alternatives.
What’s really going on here?
2022 saw the end of a 40-year bull market for bonds. For 40 years interest rates have been coming down. Mathematically that puts the price of bonds up in value.
That all ended abruptly in early 2022 as the Fed hiked rates numerous times in a row to try and get a handle on the inflation it largely created by printing and adding trillions of dollars into the economy in an attempt to ward off a large-scale recession due to Covid.
In basic terms, if you print trillions of dollars of money, and put it into an economy, it’s going to chase things.
Part of it’s going to chase stocks and bonds. Part of it will chase real estate. And part of it will choose to chase consumer goods. This is one of the main reasons stock and real estate markets were so positive in 2021. That, along with the massive slowdown in shipping due to Covid and the supply chain issues it caused, it was also a key reason for inflation.
We’re seeing the opposite now. Rates have continued to rise, and given strong job numbers and persistent inflation, it will be some time before they come down – perhaps years. That makes for a tougher environment for companies to make money in amid uncertainty about the future.
While the economy has been, stronger than expected with jobs reports surprising on the upside, stated inflation, while down from 9.1% last year to 5.6% as of late, has left the majority feeling that they just have no money.
As rising interest rates cause payments to go up, this is exacerbated by higher costs on basic necessities, such as fuel and food.
So, given that we’ve seen roughly eight rate hikes in the last year now, the economy is actually doing relatively well given the jobs numbers. However, most people still feel like they have no expendable income, which, as one might expect, continues to be problematic for stocks.
And it’s difficult to see where increased profits are going to come from without rate cuts, additional monetary stimulus or consumer spending. The lack of consumer spending is showing up in earnings, which are decidedly mixed, and will likely continue to be for the next several years.
Geopolitically, things continue to get worse. There is a real concern that both China and Iran may get significantly involved in the Ukraine war by providing Russia with substantial arms and drone sales. This has the potential to lead to a third world war if things really cascade.
As we’ve discussed before Putin will not stop his attack on Ukraine. A loss, or even a lack of victory, will now feasibly mean the breakup of the country itself due to the fact that its revenue base of selling gas and oil to Europe has been both physically and legislatively curtailed – arguably destroyed for decades to come.
Thus winning in Ukraine has become an existential threat to Putin’s Russia – it’s victory or death.
Wars are expensive. Inflation is not going away.
For all the talk of interest rates going up because of inflation, there’s an equal case to be made that rates are up because governments around the world are forced to outbid each other just to maintain the basics they need.
Onshoring or the move to bring manufacturing back to North America is another fundamental problem that will drive inflation for years.
Simple common sense will tell you that you can’t sell U.S. – manufactured products for the same price, if it is manufactured with $30 dollar an hour labour, as you can when it is manufactured with people making a dollar or two an hour.
So while there is knee jerk reaction today to bring manufacturing back to North America to ensure we do have production of the things we need, the approach all but guarantees high levels of inflation for the next decade.
Along with that comes higher interest rates. All of this leaves investors in a tough spot.
The need for professional management and a balanced portfolio has really never been greater, as we can’t expect the market as a whole to rise substantially over the course of the next decade without continued earnings growth. Thus, it will be a stock picker’s decade, so professional management of your money is fundamental to success.
As always in the world of investments, there is no complete safety anywhere. With interest rates rising, bond prices will continue to deliver moderate returns. Most importantly, inflation should negate, any returns that cash provides leaving investors that want to maintain pace no alternative but to participate in the stock markets.
We continue our strategy of regular dollar cost averaging into the market to buy the dips, which while not fancy, has produced good results over decades which we would expect to continue in the long term.
As always, if you need to speak with someone, please give us a call.
Mark, Sean, Cass, Simone & Nancy