To my clients:
It was a down week for North American stock markets with the Canadian TSX finishing down 0.7%; the U.S. Dow Jones Index down 0.1%; and the U.S. S&P 500 down 0.6%.
The major theme that has been central to my weekly updates for over a decade now is that equities should be given the benefit of the doubt at all times except when there is an imminent threat of recession. Typically I will offer key economic data points to argue why recession may, or may not, be imminent. This week I’d like to come at this topic from a different angle and offer additional perspective as to the current recession risks.
Credit conditions are a key indicator of recession probabilities. In fact, it is often argued that tight credit conditions (i.e. when it becomes difficult to obtain a loan) are the actual cause of recession. The St. Louis Fed tracks these conditions in charts which it titles “Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans”. It publishes separate charts for small, medium, and large businesses. Rather than tightening, all such charts reveal that banks are relaxing loan standards at the fastest pace seen in the last 30 years. In other words, credit conditions will not be triggering recession anytime soon. Here is the chart:
A concern often cited (and one that I have cited myself many times over the years) is the burgeoning level of debt in the world, and that surely these debt levels must ultimately have some dire consequence for the economy (i.e. might lead to recession). On this point, it is beyond argument that debt levels are at significant all-time highs. However, one must keep in mind that debt exists at the consumer, business and government levels, and it is the government level that has assumed the vast majority of additional debt since the onset of covid. In a nutshell, governments assumed this debt so that consumers wouldn’t have to. Consumer balance sheets are actually in decent shape. Even more to the point, owing to ultra-low interest rates, the cost to governments to service this debt as a percentage of GDP (i.e. the interest they must pay) is broadly in line with historical averages and has actually taken a recent dip as higher interest bearing 30-year bonds mature and are replaced by much lower interest bearing 30-year notes.
Lastly, there is an internal 6-point “recession scorecard” that Dominion Securities produces and which I have mentioned and/or presented from time to time. Each input is measured as being “green” (favourable); yellow (flashing caution); or red (showing a recessionary reading). It is rare that all 6 measures are all green, yellow or red. However, now is one of those rare times with all six inputs flashing green.
The point is that recession is nowhere in sight. I and my firm take the job of monitoring the economic environment very seriously and we will certainly become defensive when warranted (as I did in client portfolios in February 2020 when it was revealed that the coronavirus could spread asymptomatically). But now is not such a time. Client portfolios remain overweight equities.
That’s it for this week. All the best,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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Any recommendations herein are for the exclusive use of clients of RBC Dominion Securities and Investment Advisor Nick Scholte. Any other direct or indirect recipient of this email should consult with his/her own licensed investment advisor prior to implementing any investment action he/she may be contemplating.