On Jerome Powell's Wish list

Investors endured quite a roller coaster ride in the third quarter. Indeed, after a sharp rise for equities in the first half of the period, the decline that began at the end of August accelerated in September, thus bringing the vast majority of assets into negative territory for a third consecutive quarter.

 

Why all the fuss? Clearly, these turbulences reflect markets' nervousness towards the accelerated monetary tightening carried out by central banks, and especially the US Federal Reserve. In addition to opting for a third consecutive rate hike of 0.75% in September, the latter now plans to stop about 1% higher than what it forecast in June, i.e., at a target rate somewhere between 4.50 % and 4.75%. Thus, although monetary policy is not yet in restrictive territory¹ in the eyes of the markets, it seems that it will be the case shortly.

 

US Federal Reserve Chairman Jerome Powell wants to see the following before a potential slowdown in rate hikes:

 

1. Growth in gross domestic product (GDP²) which continues to run below trend

 

2. Movements in the labour market showing a return to a better balance between supply and demand.

 

3. Clear evidence that inflation is moving back down towards 2%.

 

Ultimately, the objective behind keeping the economy growing below potential and the labour market cooling are, of course, to get inflation back to the 2% target.

 

1. A restrictive monetary policy consists of increasing the key interest rate and reducing the money supply in circulation in order to combat an excessively high rate of inflation.

2. Gross Domestic Product (GDP) is a general measure of a country's economic activity based on the total market value of all goods and services that country produces in a given period of time.

 

Market review as of September 30, 2022

 

Fixed Income

 

• The Canadian bond universe retreated only slightly in September, offering some protection against significant stock market declines. Indeed, the ICE BofA Canadian Bond Universe index fell only 0.7% in September, positioning it at -11.5% year to date.

 

Equities

 

• On the stock market side, Canadian equities (S&P/TSX Composite) once again clearly outperformed the rest of the world, posting a monthly decline of 4.3%. This recent pullback therefore brings the index to -11.1% year to date.

 

• The US market (S&P 500)³ was down 23.9% year-to-date, returning into bear market territory following monthly losses of 9.2% in September.

 

• Internationally, the MSCI EAFE⁴ index suffered more significant declines. As of September 30, the index posted losses of 26.8% since the beginning of the year.

 

Oil and Gold

 

• Oil prices recorded their fourth consecutive monthly decline in September. For the quarter, the decline in WTI⁵ oil is over 25%. The price per barrel is now at a level well below what was seen before the Russian invasion of Ukraine, but still higher than at the beginning of January (+6.3% YTD).

 

• Gold prices (US$/ounce) are down 8.1% since the start of the year after its recent quarterly decline of 7.4%.

 

Forex

 

• The Canadian dollar, very often positively correlated with the price of oil, depreciated significantly in September against the US dollar. Indeed, the loonie fell 4.7% against the US dollar in September. The USD/CAD pair was trading around 0.73 USD to 1 Canadian dollar as of September 30, representing a drop of 8.1% since the beginning of the year.

 

3. S&P500 and MSCI EAFE returns are expressed in US currency.

4. The MSCI EAFE Index is an equity index designed to measure the performance of equity markets in developed economies other than the United States and Canada.

5. West Texas Intermediate (WTI) Crude oil is the North American standard for pricing oil.

 

Investment Outlook

 

The volatility that has plagued financial markets for some time now did not abate during the third quarter—quite the contrary. Indeed, after a spectacular equity rebound in the first half of the quarter, a hawkish speech by the chair of the Federal Reserve abruptly put an end to investors’ renewed optimism. In the face of this umpteenth increase in hawkishness from the central bank, expectations of rate hikes rose sharply, despite the slowdown in inflation observed during the summer months. In the end, quarterly performance was slightly positive for North American equities, which had suffered significant losses in the second quarter.

 

Initially, this summer’s market optimism was based on the prospect of a rapid deceleration in inflation that would have allowed central banks to slow—or even halt—their monetary policy tightening in the near future. The first part of the equation does indeed seem to be materializing, with a significant drop in gasoline prices helping to ease inflationary pressures. In addition, prices for a wide range of commodities have fallen significantly in recent months, including wheat, corn, lumber and industrial metals. Finally, the normalization of global supply chains continues to run its course.

 

In the end, even if a more favourable economic scenario cannot be ruled out definitely, we cannot simply ignore the call for caution that a growing number of leading indicators are currently sending us. Moreover, it now seems clear that a pivot by central banks back to an accommodative monetary policy stance, an essential condition for a sustained market recovery, will at best take some time and at worst require a recession.

 

We believe that your geographic exposure remains adequate in the current economic environment. We are maintaining our preference for the Canadian stock market, which benefits from an attractive valuation level and a sector allocation that is better suited to current market conditions. Furthermore, we remain less optimistic about the EAFE⁶ region and more specifically in Europe, where the difficult energy situation is further compromising growth prospects. As for fixed-income securities, we are maintaining a more defensive positioning as additional rate hikes are still on the horizon.

 

6. Europe, Australasia and the Far East (EAFE) are the most developed geographic areas in the world outside of the United States and Canada.

 

For more details regarding our outlook and portfolio positioning, we will be happy to schedule a call at your convenience.

 

The Duval group wishes you a colourful autumn and an excellent end of the year!

 

Kind regards,

 

Cathy, Guillaume, Marc-Antoine and Inuk

cathy.duval@bnc.ca

514 871-3474

Disclaimer: I have written this commentary to provide you with my thoughts on various investment solutions and considerations that may be relevant to your investment portfolio. This commentary reflects my opinion only and may not reflect those of National Bank Financial Group. In expressing these opinions, I try to apply my judgment and professional experience to the best of my ability from the perspective of a person called upon to follow a wide range of investments. Therefore, this report represents my informed opinion and not a research analysis produced by the Research Department of National Bank Financial. National Bank Financial is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). National Bank Financial is a member of the Canadian Investor Protection Fund (CIPF).