Equity market and the Economy: Mid-Year Updates

Head of Investment Strategy Neil Linsdell joins the podcast to provide an update on equity markets and the economy, including:

• First half of 2023
• Interest rates/economy/inflation
• Thoughts on recession
• What’s the rest of the year look like?

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Transcript

Chris: Hello and welcome to the Advantaged Investor, a Raymond James Limited podcast. The podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long-term success. We are recording this on June 20, 2023. I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department, and today Head of Investment Strategy, Neil Linsdell is joining the podcast for the first time. We'll be discussing the markets as we approach the halfway mark of the year, the effect interest rates are having on the economy and inflation, and we also discussed the dreaded R word - recession, as well as what may be in store for the rest of 2023.

Chris: Welcome to the Advantaged Investor, Neil. Hope you're doing well.

Neil: Great. Thanks.

Chris: Good to hear. Always lots to chat about when it comes to markets and the economy. So we'll jump right in. And Neil, maybe we'll just start off with what's gone on in the first half of 2023?

Neil: Well, it's definitely been an eventful first half of the year. As you recall, we had a big drama with the debt ceiling in the US. We've had interest rate hikes globally, most specifically Canada than the US, obviously our major impact and we've had artificial intelligence be all the rage and driving the magnificent seven stocks tech stocks in the us you know, powering S&P 500 ahead.

So that's really been a lot of the stories. If we look at, you know, the markets for Canada, it's been much more subdued, just a few percentage points up for the year. As I said, the S&P 500 has been up around 15%, which is markedly better. But you have to remember, 80% of that return has been from the magnificent tech stocks that we've talked about.

If you look at an equally weighted portfolio, the S&P 500 equally weighted, that's up a more modest 5%. So there's a real story about breadth in the market right now. So we've started to see some improvement, but that's been a really big focus. And the tech, like I said, our artificial intelligence has really driven it up.

The NASDAQ is up about 30% year to date. So those are the big things that we've seen in the first half of the year.

Chris: Okay. Now interest rates, of course in Canada, they just raised rates. Judging by how much is coming off from my variable mortgage now. And obviously interest rates affect the economy as a whole and sort of the inflation story has always been a big one. So how do all those three things tie in together right now?

Neil: Yeah, so the big thing about the interest rate increases is all the government's attempt to tackle inflation. So obviously, we saw this huge increase in inflation trying to get it under control. And how the government tries to do that is through monetary policy.

So we'll raise interest rates and then we'll start to see those interest rate increases, start to work their way through the economy, so they hit consumption, business spending, economic growth, and then eventually inflation. Now, what a lot of people don't fully appreciate is how long that takes. To impact inflation, which is really the ultimate goal, as we want to see that inflation rate get down under 2% or to the 2% target.

Now, once you start raising rates, which you know, the Bank of Canada started to do in March of last year, you have to look at maybe around 18 to 24 months before you get the full impact of this. So, remember, we haven't had those high rates really work their way into the economy so that it can impact inflation.

So you know, we saw 25% basis points in in March, and then 50 in April, and then 50 in June. And it wasn't until we got into July and we got that big 1%, a hundred basis point increase and then 75 basis points in September. That's still working its way through. So, you know, there's a lot more impact that I think we're going to see.

And you mentioned your mortgage. If you look at the impact on mortgages, we still have over the next two or three years, a lot of these five year mortgage terms that are going to be starting to roll over. And people as they renew, you're going to have a 40 to 60% type increase in your monthly payments.

So there's a lot of stuff still to come over the next few years. Again, you have to be patient to see these changes coming through the economy.

Chris: Okay. That makes sense. And of course you talked about how, how raising interest rates is about slowing the economy down and getting it to a more manageable level. We hear a lot about hard landings. Soft landings, no landings, recession landings. So let's talk about that dreaded R word, recession. I know we had a podcast oh about a year ago on the dreaded R word and whether it was coming or not. And obviously the easy answer is the recession is coming because they always do eventually. But maybe let's get your thoughts on the recession, where we're at and what your beliefs are.

Neil: Yeah, so there's been a lot of shifting targets in the recession and you know, as you said, are we going to have a hard landing, soft landing? No landing, well, mild recession. And I think right now this consensus seems to be we're going to get into a mild recession.

And in the US where everybody's kind of watching, the expectations have kind of shifted from, you know, Q2 to Q3 now into Q4 into the first quarter of next year. And again, this is all a matter of you have to be patient as you start to see these things work their way through the economy.

And now, as we're seeing, you know, a lot of layoffs in the US because the one of the things we look at is employment. So you've seen, you know, Disney Bell, Meta, Shopify, Morgan Stanley, Goldman Sachs, there's a lot of layoffs that have started working their way into the markets and that's going to hit spending.

And as people start to spend less, they start to be more worried about their budgets. That's when you're going to see some of these things start to hit the broader companies that we start looking at in the stock market. And as we move into the end of the year, we're going to start hit hitting some of those revenue numbers and there's going to be some, perhaps some downward revisions right on the earnings.

And then that affects what we look at the stock market, which is ultimately where we're trying to be focused. What's the impact on your portfolio?

Chris: Right. And always important to remember, of course, that the economy and the stock market are two very different things, and one could be not great and the other can be great and, and vice versa. I guess that's what, that makes sense. But sometimes those things get a little confused, so it's important I think to just note that. So what does the rest of the year look like for you then, as you're looking out into your magic crystal ball that I know all strategists have so that. So that they're on the right side, of course, impossible to do.

Neil: The magic eight ball. Well, as you said, the stock market and the economy are two different things. If we're looking at the stock market, the stock market really is a forward-looking vehicle. It anticipates a lot of things, and that's been one of the kind of concerns that we've seen.

You know, Jerome Powell talks about interest rates in the US and the concern was if the Fed went to a pause as they've gone through now, then the market would take that as a signal that, oh, interest rates are going to start coming down, and all of a sudden the stock market starts to respond positively. And you could argue that maybe that has started to happen, but we also have expectations that there's another 50 basis points coming in the US, so interest rates are looking like they're still going up.

We're not finished with this tightening. And that could continue to trickle in, which will further what we're talking about as far as the recessionary impacts. So as much as this market looks forward, it also gets surprised negatively when you see earnings results come out. So as we get into this environment as the Q2 earnings come out, and then as we see Q3, if we start getting these negative surprises, you can get short-term volatility.

So this is really what we're looking at here, right? Overall, as we start looking at forward looking, getting through this recession into 2024, maybe later. We would expect some good things. There's a lot of positive things that are going on. The Inflation Reduction Act could spur a lot of investment in the green sector and such.

There's AI, which, you know, there's a lot of questions around how much impact that will have on companies and their profitability and such, but there's a lot of positive things we're looking at longer term, and especially as we get 12 months out. Shorter term. Again, even though technically we're in a new bull market, we're 20% above the October lows. When we'd look at the S&P 500, you can still get some volatility in there. So even if you're in a, you know, a bear market, when you're in a period of declining stock prices, you can get 20% rises, right? And if you look at 2000 to 2022, you know, we still had declines, but you had, three instances where you had more than a 20% rebound right up in the prices. So you have to be a little bit cautious.

So I think right now what we're looking at is a period of volatility as we get earning shocks versus positive outlooks going forward. So expect some volatility. But still again, it's difficult to avoid the stock market and we may not have as much volatility as we anticipate and everything might start to look positive, and the caution of trying to time this market, is that most of the returns in a business cycle, in the investment cycle, come at the very early stage, when people are worried, probably sitting on the sidelines. And if you sit on the sidelines and you're not paying attention, you could miss that upside.

Chris: That makes sense. And of course, people only seem to complain about volatility on the way down – they never complain about volatility on the way down, way up.

Neil: Oh no, that's a big thing. The only risk is negative risk.

Chris: That's right. Is there anything else you want to leave us with today, Neil?

Neil: No, I, I think that's what we're looking at, you know, we're very positive long-term. We think it's, difficult to time the market. So I, I think people want to avoid trying to get out of the market and wait for the perfect time to get in. Just accept that there're going to be some volatility. If you worried about, you know, the run-up in all the tech stocks and the potential that these are at the higher end of their PE multiples going forward.

Then there's also the equally weighted indexes, for the S&P 500 which as we said, has, has not shown as much. So if you stick with value, you stick with some defensive sectors right now, you can still benefit from some of the positive stuff we see in the, in the stock market, but, you know, protect yourself a little bit if you, if you have a lower risk tolerance for that volatility.

Chris: And of course talk to your Raymond James advisor with any questions you have.

Neil: Absolutely.

Chris: Excellent. Well, Neil thank you great first appearance and look forward to having you back.

Neil: Thanks. Looking forward to it.

Chris: Reach out to us at advantagedinvestorpod@raymondjames.ca. Subscribe to the Advantaged Investor on Apple, Spotify, or wherever you get your podcast.

Please contact your advisor with any questions you have. On behalf of Raymond James and the Advantaged Investor, thank you for taking the time to listen today. Until next time. Stay well.