"Rumors of my death have been greatly exaggerated.”
A popular misquote attributed to American author and humourist Mark Twain, May 1897, after The New York Journal erroneously published his obituary. Oxford Reference
Generally speaking, in economics and investing there are only three possible directions for movement: up, down, or sideways (no change). Everything also simultaneously travels through time. In 2023, we have experienced all three: up, then down, and sideways in April.
Our extensive spreadsheet of changes in market and asset prices was shockingly subdued last month. With minor exceptions, most global equity and bond markets, currencies, and oil and gold prices ended the month largely back where they started. April is part of a larger sideways pattern. During the last six months to a year, it was evident in price graphs of stocks, bonds, currencies, and commodities. Although we’ve seen some volatility, much of the downward movement happened at the start of 2022. In hindsight, we can see that it was a necessary – if violent – price correction.
Since then, global stocks have moved crabwise. Some might call it a wide range (as in heightened volatility). However, measured by historical standards, and given the degree of shocks to absorb, it’s impressive that the S&P/TSX and S&P 500 indices traded within a plus/minus range of less than 10% for more than six months.
On April’s final trading day, we saw 12-month total returns for the S&P/TSX Composite, S&P 500, MSCI World and the FTSE Canada Universe Bond indices of 1.0%, -1.1%, 1.4%, and 1.8%, respectively. That’s pretty darn flat.
Of course, no investor wants puny returns, so why are we making such a big deal of this sideways movement? Context is everything.
Right now, sideways feels like the new up for many reasons. Global growth is slowing (remember this is deliberate to bring down inflation), earlier excesses in stock and bond markets are being worked off (in late 2021 stocks were too rich and bond yields too low), inflation remains problematic, most central banks are tightening, war in Ukraine is dragging on, corporate earnings are sluggish, cracks are appearing in the banking sector, housing markets are correcting, layoffs are mounting, and unemployment claims are rising. Despite all this roiling activity, markets oscillated but did not collapse.
Sideways movements in capital markets, especially stocks, are not unusual. When market prices deviate from fundamentals or economic reality, capital markets can adjust in two ways: prices can move rapidly (up or down) to reflect the changed environment, or prices can muddle along until the environment improves. We call these price corrections and time corrections.
Price corrections are typically swift and violent; time corrections are generally slow and tortoise-like. Early 2022 saw a price correction, while the last year has been a time correction. Today, we believe that fundamentals and prices are much closer to being in sync than they were 16 months ago. More work remains, however. Taming inflation may require additional weakness in labour markets. The result could be some near-term (and we think short-lived) risk to equity markets.
Yet, we see positives falling into place. Corporate earnings growth is carving out a bottom. Profit margins have dropped, which means that businesses are shouldering some of the inflation burden. Supply chains are rapidly repairing, and the world has adapted to the commodity shock (oil prices are little changed despite further OPEC supply cuts). After some lurching, housing markets appear to be stabilizing as interest rates settle into a more appropriate trading range. Central banks are at, or near, the end of their tightening cycles. Inflation continues to cool, albeit not quickly enough in some areas.
Here’s the big question: what comes after sideways? Right now, we see capital markets looking past near-term softness and starting to lay the groundwork for brighter days ahead in 2024 and beyond. The defining strength of capital markets is resiliency.
Despite sporadic setbacks, the long-term trend is upward. Patient investors will be rewarded. Near term, we are approaching the seasonally tricky part of the year for stocks; a cleansing setback would not surprise us. Nevertheless, we are nudging closer to up.
Canada – Strike over
For April, the S&P/TSX Composite was one of the better performers, rising 2.7% largely thanks to energy and financials. The price of West Texas Intermediate oil rose 1.5%, and concerns eased over the global banking sector. Our loonie was stable, ending the month at US$0.738, or C$1.355 per U.S. dollar.
Canada’s headline inflation rate continues to improve. Annual Consumer Price Index (CPI) inflation eased for a fifth month, falling to 4.3% from 5.2% in February. This marks a critical crossover point; the Bank of Canada’s (BoC) overnight rate is 4.5%, which is now above the inflation rate. Core inflation is still running slightly above 4.5%, and wage growth held firm at a lofty 5.3%, keeping the BoC whispering about the possibility of further rate increases. Bond markets are highly skeptical of that prospect, believing that Canada’s softening economy will keep the BoC on hold. Real GDP eked out just a 0.1% monthly gain for February, and the March estimate is for a slight decline. Thankfully, the return to work of striking civil servants will no longer weigh on the economy. Canadian bond yields fell slightly, sending the FTSE Canada Universe Bond Index up 1% as Canadian 2-year yields fell from 3.73% to 3.65%, and 10-year yields fell from 2.90% to 2.84%.
United States – Slowing
For April, the S&P 500 rose 1.5% on better-than-feared corporate earnings growth. With half of S&P 500 companies reported, earnings growth remains down 1.6%, but 80% of companies have beaten analysts’ estimates — the biggest proportion since the third quarter of 2021. The technology sector delivered many of the most positive earnings surprises. Yet, the tech-heavy NASDAQ was flat on the month, resting on its 16% year-to-date gain.
More than 100 years after banker J.P. Morgan rescued the U.S. financial system, his eponymous bank stepped in to make a fire-sale purchase of First Republic Bank, the second California-based bank to go under this spring. The wind-up comes as the U.S. Federal Reserve (the Fed) raised rates again on May 3. The Fed believes it has tools separate from interest rates to deal with financial stress. This may be true, but with Fed Funds just above 5%, higher than the Fed's preferred measures of core inflation and wages, monetary conditions are tight.
Evidence is mounting that the Fed should move to the sidelines. U.S. real GDP was unexpectedly soft in Q1, advancing modestly at an annualized pace of 1.1%; early indications point to a slower Q2. Regional manufacturing activity weakened in April, and consumer spending stalled. Treasury Secretary Janet Yellen warned Congress that the U.S. must raise its debt limit by early June to prevent a catastrophic default. The bond market believes the Fed will cut rates in 2023. U.S. 2-year government bond yields fell from 4.03% to 4.01%, and 10-year yields fell from 3.47% to 3.42%.
Europe – Surprising
European equity markets made slight gains in April as the eurozone continued to avoid recession. Manufacturing was weaker, but stronger services activity more than made up for that. Eurozone Q1 real GDP rose 0.1%, a small gain yet welcome news. Portugal, Spain, and Italy showed strength, but the German economy flatlined. Strong corporate earnings bolstered European optimism as 70% of firms reported profits that beat expectations. Earnings are down 2% – better than the anticipated mid-teens decline. Annual German CPI inflation unexpectedly slowed to a 13-month low of 7.6% in April while inflation accelerated in France and Spain. Having raised rates less than other central banks, the European Central Bank is expected to announce another rate hike.
For April, the Euro STOXX 50, German DAX, and U.K. FTSE 100 stock market indices posted returns of 1%, 1.9%, and 3.1%, respectively.
Asia – China growth soaring, mood souring
Movements in Asian equity markets were muted, except for China’s. The MSCI China Equity Index fell 5.2% in April as geopolitical risk aversion remains high. This rout happened despite soaring economic growth and stimulative monetary policy, which will continue thanks to very low inflation.
April saw a number of developments that further soured U.S.-Sino relations. Tensions escalated after the meeting between the Taiwanese President and the U.S. Speaker of the House. Treasury Secretary Yellen said in a speech that national security is of paramount importance in its relationship with China, even if that forces trade-offs with U.S. economic interests. President Joe Biden is expected to issue an executive order limiting American investment in Chinese high-tech industries such as semiconductors, artificial intelligence, and quantum computing that could benefit China’s economy or military.
Japan’s Nikkei 225 rose 2.9% as incoming Bank of Japan Governor Kazuo Ueda stuck with ultra-low rates. This maverick central bank plans to continue its highly accommodative monetary policy, a stance that creeping inflation might challenge.
Our strategy – Balanced
We held steadfastly to our asset mix in April. With stocks slightly edging out bonds, our overweight to equities was rewarded. Similarly, Canadian equities outperformed their global peers, playing well to our regional equity market positioning: overweight Canada, with neutral weights to U.S., international, and emerging markets.
Our asset-mix strategy remains well balanced: we’re overweight to equities and underweight to fixed income. Market movements have taken our equity overweight higher. Given our constructive outlook, we are allowing these increased weights to run.
Volatility in the fixed-income market was more subdued in April as bond markets are currently priced with high conviction that central banks are at or near the end of raising interest rates. We agree. Our well-diversified exposure to bonds is delivering a solid running yield. Coupon income and maturity proceeds are being reinvested at higher yields. While this is not our base-case scenario, if the economy slows too much we believe our bond positions will provide a level of safety.
The last word – De-dollarization
With so much geopolitical turmoil erupting around the globe, and Congress unable to resolve U.S. debt ceiling and deficit conflicts, pundits are once again wondering if the greenback is nearing its demise as the world’s reserve currency.
In fact, there is no serious alternative to the U.S. dollar’s dominance as the status quo. Historically, adopting a new reserve currency has been a slow, incremental process. The dominant global currency has long been associated with the most prominent countries or empires, but the last transition took more than 30 years to play out. Around 1916, the U.S. economy surpassed Great Britain’s, but the British pound sterling didn’t lose its reserve currency status until after WWII.
A modern global reserve currency is the primary medium for international transactions, so it must meet many conditions. It must be readily convertible (no capital controls, plenty of liquidity) and belong to a free-market, open economy with entrenched democracy and a well-established, trusted court system. Financially, the currency must be a store of value (in a regime with stable inflation). Among the most daunting hurdles, the new reserve country would need to facilitate trillions of dollars (or yuan, or euros, or whatever) worth of safe assets to a world looking to diversify away from the dollar.
Saying you want to use a currency is easy, but finding a way to do it can be hard. Short of holding physical currency notes (not practical on a large scale), a currency must be kept in some sort of asset. That asset must be safe and reliably convertible to something else or accepted as a form of payment. The U.S. provides a large pool of globally transacted U.S. government debt to fulfill this requirement. The euro and Chinese yuan do not.
Yes, the euro is a common currency, but there is no real pan-European debt instrument where it could be parked. China has government bonds, but they are not easily transacted. A few countries worried about the U.S. weaponizing the dollar through sanctions are, unsurprisingly, discussing alternatives. In reality, it would take a seismic shift to dethrone the greenback. Talk about switching to alternatives remains just that – talk.
The U.S. dollar now finds itself in a situation similar to Mark Twain’s: rumours of its death are greatly exaggerated.
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