Jim Allworth Call
We held a call on Tuesday with Jim Allworth, Chief Strategist for RBC Wealth Management, who took us through his views on the market and the economy. Unfortunately, we had some recording issues, so we will instead provide a summary of Jim’s thoughts.
Coming into 2020, we had gone through one of the longest economic expansions on record with the last U.S. recession occurring in 2008/09. Jim made a point of noting that because of the large size of the U.S. economy, it is U.S. recessions that matter most to both the global economy and stock and bond markets.
Normally, recessions are brought on by a number of factors, but the key one is that an overheating economy causes the U.S. Federal Reserve to raise interest rates to try to cool the economy, which in turn leads to tightening financial conditions. Sometimes, but not always, these tightening financial conditions cause a pronounced slowdown in the economy and ultimately a recession.
None of these conditions existed at the beginning of 2020, which made the 2020 recession unique. It was essentially a recession caused by government edict.
Now, we have a playbook that is roughly 90-years old that instructs how to deal with recessions. The basics are – dramatically reduce interest rates to loosen financial conditions and increase government spending to offset the loss of jobs and consumer purchasing power. As Jim noted, policymakers met the 2020 recession with “shock and awe”.
The keys to the stock market’s recovery in 2020/21 were:
- Massive stimulus marked by near 0% interest rates and huge government spending;
- A skepticism among investors that things would ever return to normal, which led to strong performance by so called “stay-at-home” stocks and poor performance by everything else;
- A dramatic shift that occurred largely because the five to ten year vaccine timeframe that we generally thought to be the norm was greatly accelerated with not one, but four highly effective vaccines achieved in less than a year.
So where are we now?
Jim pointed to the Congressional Budget Office (CBO), which forecasts better U.S. growth in 2021 and 2022, before a return to sub-2% growth in 2023 and beyond. Jim noted that the CBO’s forecasts tend to be quite good, so he uses that as his baseline. Jim also pointed to a recent piece by RBC Capital Markets, which noted that when U.S. growth is above 2.5%, more economically sensitive stocks (cyclicals) tend to outperform (think banks, consumer discretionary, some industrials, commodities), but when growth falls below this level, stocks that can grow in spite of low growth (think technology, healthcare, utilities, some industrials such as railroads) tend to outperform. We have seen a shift to the former since November (what has become known as Pfizer vaccine Monday) and we may continue to see cyclicals outperform into 2022, but this outperformance is unlikely to be sustained beyond that unless U.S. growth surprises to the upside in 2023 and beyond.
Against this backdrop, the market is worried about three things:
- Virus: variants or the government response;
- Inflation: we have had 20-years of low inflation – COVID has awakened commentary on this. Much of the inflation we are seeing is based off of prior year comparisons (we were largely shutdown a year ago) and the U.S. Fed views it as transitory. People who have been around remember the 70s and prolonged periods of high inflation. Inflation was eventually beaten by U.S. Fed Chair Paul Volcker. Volcker did not really have a magic bullet (although, history has been kind to him), but rather as Jim noted, Volcker basically “pushed very button on the elevator” and ultimately beat back inflation;
- A double dip recession.
On the issue of another recession, Jim cautioned that the market always gets worked up about the economy going back into recession after it has just emerged from one. He pointed to two things that give him comfort:
This is a scorecard published by RBC Global Asset Management on where we are in the U.S. economic cycle based off of 14 metrics (listed down the left side). If you focus on the percentages at the bottom, you can see that ~87% of the various indicators are either at the start of the cycle, early cycle or mid-cycle. This would indicate that recession risks over the next 12-18 months are very low absent some major shock (i.e. another massive wave of COVID that shuts down the economy). Jim relies on an indicator that I was fond of using back in my days in Capital Markets:
This is what we called the Recession Scorecard. As you can see, all recession indicators are currently in the green. Further, they generally give a lead time of 6-18 months, so even if they do flip from green to yellow to red, the recession is still likely some months off.
As Jim noted, U.S. recessions are the enemy of equity investors. The simplest way to think about this is – stocks are valued on a price to earnings (PE) basis. The higher the multiple of earnings investors are willing to pay, the higher the stock price. Recessions lead to a reduction in corporate earnings (the E gets smaller) and a reduction in the multiple. Thus, price gets hit in two ways.
Jim did add that while recession risks are low and thus the backdrop is favorable for stocks, the risk of a correction is always there and hard to forecast. Stocks have a 10% correction in roughly two of every three years, but they generally come with little warning and they always represent buying opportunities.
The Dollar
I asked Jim about the Canadian dollar and he felt that it was close to fair value at around $0.83. He noted that higher oil and commodity prices have helped, but the bigger driver has been relative interest rates. Canadian short-term rates, while low, are still ~0.5% higher than they are in the U.S. If this shifts (i.e. U.S. short-term rates begin to rise), CAD will likely come under some pressure; although, there are no signs of this at present.
Housing
I asked Jim about the housing market and he noted that immigration remains the biggest driver of housing as Canada simply lacks the supply in big urban centres to meet the demand. Thus, he did not see a lot of danger signs here, despite the run-up in prices.
We have also attached Jim’s latest presentation. He did not use it during the call, but it has some valuable stuff in it for those who are interested.