This year has presented investors with a rude awakening to the consequences of a regime change from easy money, low inflation, a relatively peaceful geopolitical environment. We have now climbed over to the other side of this fence. It’s naïve to think that the pain is going to be “one and done”. We are likely to be in a recession next year as leading indicators for economic and corporate earnings growth have yet to find a bottom. While the compression in equity valuation multiples has priced some of the bad news, it is difficult to see equities mounting a sustained rally until the earnings outlook turns the corner. Inflation remains a problem for the world economy. But with global economic demand slowing, and some evidence of pipeline inflationary pressure receding, the inflation situation might turn a little less difficult into year’s end.
Central bank policy rates are expected to level off as 2023 progresses. In fact, interest rate cuts are now being priced for the Federal Reserve starting as early as the second quarter of next year, with a similar trajectory anticipated for the Bank of Canada. European rates are priced to flatline after this year’s tightening campaign draws to a close. The Federal Reserve, for example, recently said that the pace of future rate increases will now become more dependent on the message from incoming economic data, and the data they are referring to has been softening.
The bond market outlook hinges on inflation’s future direction. There is a good chance that inflation is likely to begin rolling over into year’s end, However, if central banks decide to take their foot off the brake too early, this relief might only prove transitory. Commodities have become a favoured investment during this period of high and rising inflation, offering some pain relief in a portfolio, however, prices have started to decline in Q3.
Looking ahead, we foresee negative earnings revisions, given continued supply chain issues, weakening economic growth, ongoing input cost pressures and a growing inability to hike selling prices. At the same time, there’s little question rates of inflation will fall from their current lofty levels due to the law of large numbers kicking in. Investors experienced the full brunt of the renewed downside correlation between stocks and bonds during September, historically the worst month of the year. For the first time since 1938, the S&P 500 closed the quarter with a negative return (-5.28%) after earlier rising more than 10% (+14% July through mid-August gain).1
Roland Orban, CIM, PFP, Investment Advisor
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