Market and Portfolio Update

Happy New Year!

And we are glad to say that a tumultuous year for both stocks and bonds, is now behind us.

Yet while we consider 2023 is likely to be better, it may not really seem that way for a while.

At least while the fight by central banks over inflation must continue and to do so without incurring a deep recession and roiling markets further. They must do that in the face of continued COVID-19 issues and resulting weakness in China, the relentless battle for Ukraine and the West versus Russia, a further breakdown in Crypto currencies and potential for a contagion, and a bitter divide in U.S. congress.

On the upside, market will look 12 – 18 months out and expect to see a light at the end of tunnel and likely improve significantly by the second half of the year.

 

Red Zone:

Regarding the portfolios and investment strategy, at the beginning of December we saw our Stoplight; Equity Action Call move fully into the Green Zone. Unfortunately, within just a couple days, the market pulled right back on all the negative news. The typical Santa Rally failed to produce. We did take some of that downside, but fortunately we are closely watching our shorter term signals. They quickly flashed to Yellow then Red Zone and hit our “stops” that we had set up to protect on further downside. We were able to avoid about half of the pullback and continue to be in a position to defend further downside and potentially pick up all the upside should markets rebound.

The market is currently trending very much “sideways” close to the lows of the year, with one day up, the next down. Therefore, the portfolios are sitting on a lot of cash (money market funds) and some alternatives. Less than 30% of the portfolio is invested in stock ETF’s.

 

Probabilities:

Every day our shorter term signals have us looking at the probabilities for the next move in the market: Why? Because this is exactly what the computers and algorithms that now trade 80% of the market are looking at. We are not looking to beat them – but with the structure of trading they provide, we can and will trade along side them.

The market pulled back and has since been moving sideways since mid-December. It will only do so for so long until some sort of news or catalyst pushes investors to consider how it will evaluate the new current value of the market. If it is higher or lower, the catalyst will drive it in that new direction. Until then, the cash and alternatives will protect us.

That said, the greater probability from a technical perspective is that this may be the bottom in which case any sign of a breakout to the upside will have us invested. And in a safer position as starting from close to the bottom, with the potential for picking up what may be a very nice initial move in the markets.

Alternatively, the negative news may be too overwhelming, and we may see a catalyst for further downside. In which case we simply sit tight and allow the ETF’s we hold to profit from the downside. We may look to add more alternatives that can profit form downside and that may include Gold, which is finally beginning to act like the safe haven it has been in the past. For example today as of writing, markets are pushing the markets lower and yet we are positive.

In all cases, we will “sit tight” for the breakout until it happens. And upon getting on offense or defense, we are closely watching and utilizing the shorter term signals and “stops” to protect us. No matter the direction, we are prepared to navigate whatever the news brings us.

 

Back to the Outlook – what are the risks?

We would like to begin with a viewpoint on inflation and rates. Rates will continue to rise and with it the risk of a recession. The question is how deep. The U.S. Fed has even intimated that a upside in the stock market may only exacerbate inflation and the need to keep the market lower for longer. High inflation also comes with lower unemployment. The central banks have also indicated that it will take more job losses and higher unemployment before we see inflation decline. We have already seen significant job losses in the tech sector. And even the big banks in Canada have begun layoffs and or hiring freezes. We expect to see more across the board.

For more, we provide the following comments form our BMO Capital Markets Senior Economist; Sal Guatieri.
 

New Year, New Problem

 

  • If 2022 was all about inflation, 2023 will be mostly about the aftershocks of controlling it. We expect a downturn, though it should be relatively mild so long as inflation behaves much better this year.
  • As the economy sags and inflation slows, central banks will put policy in park, though reversing gears is likely a 2024 story.
    • Still, the economy is losing altitude and faces a bumpy landing in 2023. We still lean toward a mild slump in the first half of the year due to tighter financial conditions.
  • We still see the risks tilted toward sticky inflation, higher interest rates, and a weaker economy. However, we won't rule out a possible soft landing if inflation surprises to the downside.
  • Interest rates likely won't rise as much in Canada as in the U.S., but that doesn't mean its economy will fare any better. Canadians are more indebted and, unlike most U.S. homeowners, don't have the luxury of 30-year fixed-rate mortgage terms. Historically, when the U.S. economy spins in reverse, Canada often gets vertigo.
  • Click here for the full report

 

 

On the seemingly endless war and invasion by Russia in Ukraine, the Russians are losing and even this past week the Russian army has shown their continued lack of desire to fight and inept ability to win. This following summary comes from the always well-informed Greg Valliere, Chief U.S. Policy Strategist, AGF Investments, with whom we have had webinars with in the past:

 

  • First, the stunning ineptitude of the Russian military, which allowed troops to use personal cellphones in Donetsk that pinpointed their locations, allowing Ukrainian forces to kill or wound hundreds of Russians earlier this week.
  • Second, Russia is losing the air war, as its Iranian drones are easily shot down by the quicker Ukrainians.
  • Third, rather than cutting back on arms shipments, countries like the U.S. and France are sending more weapons. Washington has agreed to send more Patriot missiles and is considering shipments of Bradley fighting vehicles, which may be announced within days. And Paris is considering a major new shipment of light tanks.
  • Fourth, the weather in Europe has been unseasonably warm, reducing the threat that resolve against the Russians would crumble. Natural gas prices have plunged.
  • BOTTOM LINE: Vladimir Putin has been humiliated, at home and abroad, and that makes him dangerous. But truce talks by spring are increasingly inevitable — and the cellphone massacre will be viewed in future years as a major turning point.

 

On China’s precarious reopening bounce, this from Investing.com:

 

Getting worse before things get better is a theme that extends to the world’s other economic powerhouse, China.

While the fate of wars is inherently unpredictable, the progress of a lethal virus is typically much easier to forecast. China’s Communist leaders, rattled by the first sign of protest against their party, have thrown caution to the winds and effectively let COVID-19 rip. Herd immunity and the release of animal spirits by Chinese consumers should follow, but only after a wave of infections and deaths unlike anything seen so far in the three years since the virus first showed its face in Wuhan.

For the last couple of years, stringent public health regulations have been the chief culprit for anemic Chinese growth. But next year, with regulations largely lifted, the key factor will instead be fear of a virus for which Chinese medicine still has only partially effective cures. Fear may stay within manageable limits as long as China’s health system is not overloaded, and recent reports of big increases in emergency capacity suggest that the authorities are at least trying to get ahead of the curve. However, if cases outrun system capacity, then deaths will spike and the behavior of China’s consumers and industrial workforce – such as those packed cheek-by-jowl in Apple’s iPhone City in Zhengzhou – will become unstable in the extreme.

 

Surprisingly given the concerns in China, the Emerging Markets, particularly the Far East, are beginning to look stronger with those markets have taken a bigger hit over the past couple years and are now trying to open up. Should they hold here, it could see us adding some limited exposure.

And a good summary from Investing.com on the Collapse of Crypto:

 

  • Talking of gambling, 2023 is shaping up to be the year when crypto’s luck runs out. The last 12 months of governance scandals, culminating in the grotesque collapse of FTX and the arrest of its founder Sam Bankman-Fried, have eroded confidence so badly that one more big implosion may be enough to finish the whole asset class off completely.
  • There is no shortage of candidates, but the spotlight on two “too-big-to-fail” names will be particularly intense. Both Binance – the world’s largest exchange – and Tether, which operates the world’s most valuable stablecoin network, have failed to dispel doubts about the adequacy of their reserves and the legitimacy of their business models in recent months.
  • Events in December have set an ominous tone for the months ahead: Mazars, the law and audit firm hired by Binance to ‘attest’ to the quality of Binance’s reserves, withdrew its attestation last week and suspended all its work with crypto companies. Critics also mutter darkly about evidence that Binance’s U.S. operations are no better protected than FTX’s were. And don’t even mention the DoJ investigation into suspected money laundering on behalf of Iran and others – which is likely to reach its conclusion next year.

 

And lastly, we provide the following comments from our BMO Wealth Portfolio Management Strategy Team to which we think best summarizes what to expect going into this new year:

 

  • Equity Strategy: The year 2022 was volatile and difficult to navigate with seemingly very few places to hide both for equity and bond investors. This created an understandable general feeling of anxiety and pervasive bearishness among investors. While we were unabashedly bearish and recommended a very defensive positioning all year, we are now looking "over the cliff" and are moving portfolios to benefit from the unavoidable recovery we foresee in 2023. This being said, we expect the next few months to remain volatile but economic momentum should pick up (from low levels) in the second half of the year with an associated far stronger performance from risky assets and stocks in particular. As our readers know well, securities markets are primarily influenced not by absolute numbers but by the trajectory of key macro variables. On that front, the situation is already improving for inflation - though it will be a slow painful slog to get back down to the 2-3% range. The missing ingredients are an improvement in growth and housing momentum, and that's what we think will happen in the new year. As always, the stock and bond markets will discount these improvements well before we see the evidence in the "real world".

 

By far our greatest concern is for inflation and the potential for a soft landing or a deep and hard landing into recession. The remainder of the risks may not cause a market breakdown but will certainly continue to create higher levels of uncertainly and with it, volatility.

 

Opportunity is still with us:

We are in the Red Zone but as we are very close to the recent bottoms, we see a higher probability of approximately 60% for markets, at least in the short term, to move to the upside. Initially, the markets could move up to the high before the recent pullback in early December. We will look to take advantage in that upside and then get defensive again as we wait for the next move. There is still however a 40% chance of downside risk. Accordingly, we must wait for the breakout of markets, in either direction, and maintain protective stops and positioning no matter which way they take us in navigating these precarious markets. Unlike buy and hold, there are great opportunities going forward, in either direction.

 

We wish you all the best in in 2023!

 

Best regards,

John & Megan.