In the financial markets, investors’ attention has shifted from drifts accompanying galloping inflation to the fear of a recession. Between the two, stagflation would like to manifest itself.
We see, moreover, the central banks making an unconditional commitment to restoring price stability and using a firm tone, projecting key rates above 3% — beyond the so-called neutral rates — by the start of 2023, an increase that would come on top of the effects of the end of quantitative easing.
But beyond the hardening of intentions also aimed at preventing an unanchoring of inflationary expectations, we can already see that, only halfway through this course, the latest increases in the overnight rate are producing certain effects on the request. We see them here and there in the goods and services sectors in the United States. The erosion of household confidence is manifesting itself in spending on durable and discretionary goods, which is slowing industrial production and the rate of utilization of manufacturing capacities, while the cooling of the real estate market, on both sides of the border, surprises analysts with its speed.
To add to it, the Conference Board revealed that 75% of the 750 bosses questioned in the world considered either that a recession was looming on the horizon, or that it was already effective. It should be recalled that the American GDP contracted in the first quarter and that the Atlanta branch of the Federal Reserve revised its growth rate forecast for the second quarter to 0%, reads in a text of the ‘France Media Agency.
Bay Street caught up
On Bay Street, the sudden sharp contraction this week in the S&P/TSX index is evidence of this shift in concerns towards recession, even if inflation has not said its last word, as the statistics on the inflation could testify. consumer price index, expected to rise on Wednesday. Because historically, inflation is well suited to a Toronto Stock Exchange under the influence of the weight of raw materials and the oil and gas sector in its benchmark index. Moreover, an exchange-traded fund (ETF) engaged in oil and gas can easily post a total return of 40% since the beginning of the year.
The benchmark index of the Toronto floor fell 6.6% this week, and thus recorded its worst weekly performance in more than two years and inflated to 14% its decline since the beginning of the year.
Elsewhere, on Wall Street, the rise in interest rates to fight against the inflationary slippage then, now, the increase in the probability of a recession weighs down the benchmark indices, under the influence of highly sensitive technology stocks in terms of relates to the cost of money. The S&P 500 is now down 23.5% from its Jan. 3 high to Thursday’s low, and the Nasdaq is down 33.7% from its November high. Here, an all-tech ETF can easily book a paper loss of more than 32% year-to-date.
In other asset classes, losses on paper hover around 15%, whether one is with a conservative, balanced or bond portfolio – with equities and bonds showing a positive correlation echoing the upward pressures on rates. Among the lesser losers, high-dividend, value-equity, or pure utilities and infrastructure ETFs show negative returns year-to-date, below -5%. Added to this are liquid alternative funds, with a Scotiabank Alternative Mutual Funds index down 2.4% after five months.
We see investors redirecting their cash to defensive stocks and using the cost averaging method to lower the average cost of their existing positions. Portfolio managers are also structuring their strategies around bonds in order to take advantage of higher rates after a long period of weakness, and to benefit from the gains at maturity to be expected from bonds already issued, seeing their prices depress below the rise rates.
According to a review by National Bank, the S&P 500 has experienced 11 episodes of correction of 20% or more (peak to trough) since 1956, eight of which were accompanied by a recession. The decline extends over 297 days, on average, if it is accompanied by a recession, 141 days otherwise. The total loss of the index reaches 37% and 28% respectively.
We are currently at 165 days.