Happy Groundhog Day!
I pulled that Dad joke on my kids this morning. They didn’t think it was funny either.
Markets have been strong and our models as of the end of January have been ahead of the markets. We are high in the Green Zone in our mid-long term Equity Action Call. Even though our shorter-term signals, or Footsteps, have seen a minor pullback from the recent highs, it is still within expectations after the run up since the end of October. More importantly, our indicators are showing that markets are still running neatly in their “channel” on their overall path higher.
There is no concern yet, even after such a run, but we will be monitoring closely for a breakdown at both the “index” level for a step off that path, and on each individual stock level to look whether to replace positions with ones with relative strength within the Green Zone. Alternatively, we would look to move to more defensive positions if needed, and as a last resort, to cash of there is a more distinct rollover.
Markets continued the run from the bottom, as investors became more comfortable that the central banks around the world are seeing a moderation of the inflationary environment. That has led to the view that rates may be coming down in the spring, or at worst, no longer increasing. The Quantitative Tightening (QT) we saw the past couple years -- that is, the reversal of the liquidity the Feds of the world were pouring into the economy from the bottom of 2009 to spur on growth and some inflation -- has been pulled back.
With those prospects of rates topping out, and even coming back down, and with the ending of the QT, it becomes less expensive to do business and company prospects improve. Investors have been looking forward 12 – 18 months and have liked what they’ve seen, resulting in the financial market upswing.
Inflation does seem to have slowed but economic conditions, more so in the U.S., still appear to be strong. Many current factors depend on the next moves by the central banks. Earlier this month, the Bank of Canada, and then yesterday the U.S. FOMC, both decided to hold rates steady. Most importantly, that means that rates may be able to come back down should the current inflation trends continue. Most of the major central banks around the world have indicated the same (except maybe Japan which is still at extremely low rates). The question now arises, however, is not if rates will come down, but WHEN?
If the banks wait too long, then the effects of higher rates and the failure to end QT could slow the economy too much and send us into a recessionary environment. Certainly, Canada is already slower than the U.S., but for both countries, at least for now, a hard landing recession appears off the table. Many analysts recently were more expecting of a soft landing globally and now are thinking we may avoid any real recession at all.
Should rates begin to come down too soon, and or too quickly, it could see the spectre of inflation rise again. It is indeed a balancing act that all the central bankers must contend with. With the US indicating yesterday in their announcement to hold rates, they also intimated that they do not see rates coming down as quickly as investors had first suspected. Many were pricing in a rate drop come as early as late March and it is now looking like at least late May or even further, depending upon the data. Hence, the market had a minor pullback on the news. Here are comments from our Economics Dept.:
The FOMC kept the fed funds target range at 5.25%-to-5.50% today, for the fourth consecutive meeting (the last rate hike was in July). And the forward guidance formally dropped its ‘tightening bias’ (recall the “any additional policy firming” phrase). It now says: “In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”
Two things immediately stand out. While the signal here is that the next Fed action will likely be a rate cut, the “any adjustment” reference means a possible rate hike is not being completely ruled out (although we reckon it would take an extreme data development to elicit it). More importantly, although rate cuts are coming, they won’t be happening anytime soon given the “gained greater confidence” criterion.
Elsewhere in the statement, economic growth was referred to a “solid” (as opposed to having “slowed”), the reference to “tighter financial and credit conditions” was dropped because they now are becoming easier, and the risk assessment was rejigged. It now says: “The Committee judges that the risks to achieving its employment and inflation goals are moving into better balance. The economic outlook is uncertain, and the Committee remains highly attentive to inflation risks.”
In the press conference, Chair Powell said the policy rate was probably at its “peak” and that, “at some point this year”, will likely be “dialed back” from its “restrictive level”. But the timing has yet to be determined. Importantly, he judged a March move was "unlikely". Powell mentioned the FOMC needs to see more of the “good” inflation data they are now seeing (he mentioned it several times). Rate cuts are coming but 'later in the spring' is looking like the (potentially) earliest date.
There are other concerns that the market must also contend with. The main one being a slow down in China where one of the largest real estate companies there, Evergrande, is now in liquidation, with growing fears that it could lead to more contagion in the large real estate sector there. Their markets across the country generally remain under pressure. In North America as well, real estate is looking like a bigger risk and may lead to difficulties for the banks. A lot of that has to do with the work from home and employees not returning to office or in a lesser capacity. Those large behemoth buildings are still relatively empty, and leases are coming up and may not be renewed on highly mortgaged properties. We did see financial services and banks also pick up nicely from the bottom, but on this news, we are seeing a bit of weakness there and may need to reduce the exposure to the bank stocks.
The geopolitical stage is still an obvious concern, and even more so now with a recent attack on American personnel where 3 soldiers were killed and 25 injured in Jordan. The U.S. will have to retaliate in some format. Should that mean boots on the ground, or some sort of contagion of the war in the region, it may become an area of concern. An escalation could dramatically increase volatility. The administration has probably been too slow about responding to the situation of almost 200 attacks now, and this being the first with confirmed harm. They are, however, now being properly cautious on their next moves to avoid expansion.
The last item we are watching is the whole Artificial Intelligence strategy. A number of the tech companies including the big seven stocks just announced the spending that will be required for research and development, servers required and the amount of production (i.e. AI computer chips) just to keep up to demand. These costs could limit revenues and maybe cause some headwinds to their stock prices. Remember, the big seven were also the biggest drivers of the indexes last year. However, even writing here as of today, these stocks are bouncing back nicely, and investors seem to be taking this in stride.
There are indeed concerns to be wary of, and a fair bit of them in the last month. Yet the market has continued to “climb the wall of worry” and push to the upside. Markets that do not go down on bad news are considered strong markets.
As we discussed last month, we are in a U.S. election year which tends to be strong for the markets historically. Markets are also coming off the major lows we saw in 2022 and into last fall. These corrections tend to be followed by extended upside markets.
We like the changes we made in the fall to focus on maintaining a good number of core positions and thus avoid some of the effects of short-term whipsaws. We will continue to watch each position and the indexes for rollovers, but for now at least we are fully invested.
The fundamentals of potentially sideways-to-lower rates and an end to QT are very positive drivers for the stock markets. There is, as always, a potential for noise and volatility, but at least for now, markets are comfortable. From a technical view, we are in the Green Zone in the mid-long-term outlook and our short-term channels are holding strong. They saw some pullback from the highs, but all bounced perfectly off their “support” lines like they should. The computers and algorithms that now trade 80% of the market are also watching. We are not going to beat them, but we can and are trading alongside them and take direction from them as needed. At this point, we are fully invested, and should our lines break, we will look for stronger positions, or if needed, move defensively.
Just a reminder for those that still need to make RRSP contributions, the deadline is approaching, and for those that have yet to make the TFSA contributions, the limit this year is $7,000 .
Best regards,
John, Victor and Megan