To my clients:

It was a mixed week for North American stock markets with the Canadian TSX risng 0.5%; the U.S. Dow Jones Index falling 2.9%; and the U.S. S&P 500 falling 3.0%.

In spite of my assertion last week that, absent recession, we are probably “close” to a market low, it was yet another tumultuous week for stocks. Strong bouts of equity market volatility usually don’t disappear overnight, and the current multi-month swoon is proving this to be the case once again. While equity indexes attempted to stabilize early in the week, on Wednesday the S&P 500 and Dow Jones Industrial Average traded down 4.0 percent and 3.6 percent, respectively, the biggest single-session declines since Q2 2020 during the acute COVID-19 period. High inflation, ongoing supply chain problems, and concerns about economic growth - along with wariness about the Fed’s ability to effectively right the ship - continue to weigh on the market.

This indeed is a unique period with peculiar challenges that are well outside the scope of a normal business cycle. With the Q1 earnings season just about finished, the S&P 500 has delivered much stronger earnings per share growth compared to the consensus forecast before reporting began (11.8 percent versus 4.7 percent) and higher revenue growth (13.8 percent versus 10.8 percent) on a year-over-year basis. Beat rates and the magnitude of surprises have also been high. Also, profit margins have deteriorated less than initially expected (-3.0 percent versus -7.3 percent). Even when the ultra-robust Energy sector is stripped out of the data, both S&P 500 earnings and revenue growth are up 6.4 percent and 10.5 percent, respectively—not bad considering very lofty comparisons in the year-ago period. If one judged the quarter on these figures alone, everything would look fine. But there is more to the Q1 earnings story as indicated by retailers such as Target and Walmart noting that customers are beginning to shift their purchasing habits in response to high inflation. Of course this is a concern, but in our opinion we have likely hit peak inflation and the year-over-year comparables should begin rolling over through the remainder of the year.

With the 4.5 month downturn in markets persisting, it should be no surprise that stock market sentiment has deteriorated significantly. Among individual investors, it recently declined to one of the most bearish levels in almost 35 years according to a weekly survey by the American Association of Individual Investors (AAII). And it’s not just individual investors who currently have gloomy attitudes about the market. In recent weeks, sentiment of institutional investors (managers of mutual funds, pension funds, and hedge funds) has likewise fallen to very bearish levels based on a variety of indicators. Yet here is the rub (and I mentioned this in last week’s update also): when sentiment is this negative, this is not the time to give up on the market in my and RBC’s opinion. Extreme sentiment readings are often contrarian indicators for market performance. When investors’ attitudes are rather bearish, the market often rallies within a 12-month time span. To us, the very gloomy attitudes about the market signal that even if volatility persists and there is additional downside in the near term, if history is a guide, the market has the potential to upend the majority’s expectations and deliver worthwhile gains within 12 months from now.

Lastly, it’s important to remember that our recessionary scorecard still does not foresee recession. In our opinion, the current environment will prove to be a “growth scare” and not a recession. While no two eras are identical, and as I said above that there are some unique factors at play this time around, I think the current environment will prove similar to the 1994 Fed rate hiking cycle when the Fed raised rates by 3% over the course of the year, yet recession did not ensue. In fact, many clients might recall that the second half of the 1990’s was exceptionally strong for both the economy and the markets.

As uncomfortable as it may be, stay the course.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
3200-1055 West Georgia │ Vancouver, BC │ V6E 3P3
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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.