December 16, 2022

Quarterly Newsletter - Fall 2022

PATIENCE AND RESILIENCE

2022 will go down in history due to unexpected geopolitical and economic events. Top central bank strategists didn't foresee inflationary factors, such as the Russian oil embargo, the war in Ukraine, supply chain issues, labour shortage and China's COVID resurgence. Have central banks reacted too late to normalize discount rates moderately and achieve a soft landing for the economy to avoid recession? It's easy to put it that way now, but the reality is that high inflation had been on our doorstep for months.

At the time, the Bank of Canada and the Federal Reserve didn't see things unfolding this way when they decided to raise their rates. This will cause a serious economic slowdown in the coming months. The risk of a recession is looking more and more likely in 2023, but the stock markets are already anticipating a drop in corporate earnings, with the S&P 500 falling more than 25% in 2022. Should we be concerned? We're seeing a recovery from the trough, with rebounds in October and November. Since 1980, the S&P 500 has fallen 25% or more on 7 occasions. But after these dips, the average has gone up 10.1% over 6 months; 24.9% over 1 year; 40.4% over 3 years; and 111.0% over 5 years! And that's good news.

Is it different this time? Probably. But we know that the stock markets have always recovered after every crisis, after every recession. In addition, this current inflationary episode is at a historically low level, and we're a far cry from the recessionary years when no jobs were available! This will help reduce the intensity of the recession if the economy slows.

Individual and institutional investors expect stagflation to rule around the globe in 2023. Stagflation is the combination of economic stagnation (even contraction) and sustained inflation. This is a realistic scenario with a looming recession and inflation remaining above target in 2023. This won't stop the major central banks from gently tapping the monetary brakes in the short term and then ramping up (dropping the key rate) when inflation starts a long-term downward trend. When? Starting in the second half of 2023?

In the stock market, the S&P 500 is expected to move between -10% to +10% in 2023. Individual investors are giving this scenario a 57% probability rate, and institutional investors are giving it 54%. About 20% expect the S&P 500 to appreciate 10% or more and contract 10% or more. With the stock market as a beacon on the horizon (12 to 18 months), I'm siding with the optimists for 2023 (both for shares and bonds). We expected a recession and stagflation in 2022. Inflation has already started to slow, giving central banks some breathing room to achieve their goal of reducing sustainably toward target levels, without too much damage.