To my clients:
It was an up week for North American stock markets with the Canadian TSX finishing up 3.3%; the U.S. Dow Jones Index up 2.9%; and the U.S. S&P 500 up 3.9%.
Well, markets have certainly had a topsy-turvy two weeks and, I must say, it was a distraction while I was away on holiday last week. But, in spite of the distraction, I remained committed to my viewpoint as expressed in my last update on August 2nd in which I wrote the following:
Again, at this point, I don’t believe recession to be the base-case, instead viewing the current economic softening as the aforementioned “normalization.” Further, even if recession odds grow to be the base-case, will it be deep or mild? I can’t envision anything worse than a mild recession. Further still, and perhaps MOST IMPORTANT, is the fact that the Fed has LOTS of room to cut rates materially and quickly if need be. The Fed could cut rates a full 1, 2 or even 3%, and still have the overnight rate sit at levels above where they were just before the pandemic. If/when the Fed begins cutting to stave off recession fears, this kind of ammunition will significantly cushion both the economic and market downside.
Something that I didn’t know when typing that August 2nd update was that the Bank of Japan would, for the first time in 17.5 years, surprise markets and raise rates by 0.25% that same weekend. This surprise rate hike (as well as accompanying messaging that the hike might be the first of several) led to a very rapid unwind of the so-called “carry trade” which was a popular strategy amongst many large hedge funds. In this case the carry-trade involved borrowing Japanese Yen at effectively no-cost and using those Yen to buy U.S. (and other developed market) stocks. But when the Bank of Japan raised rates such that borrowing Yen was no longer free, and with expectations that further rate increases might follow, those hedge funds rapidly sold the U.S. (and other developed market) stocks on Monday leading to the worst day in nearly two years for the markets. This development had nothing to do with the softening U.S. labor environment revealed the prior Friday to which my comments above were directed. Unfortunately, the coincident timing muddied the proverbial waters, and it superficially seemed that expectations for a recession had become the market’s base case scenario.
Thankfully, in the intervening two weeks, the selling pressure from the unwind of the carry-trade has run its course while, at the same time, economic data has re-affirmed that both inflation is abating AND the economy remains resilient. On inflation, the Producer Price Index came in below expectations, and the Consumer Price Index dipped below 3.0% on a year-over-year basis for the first time since April of 2021 (and, the annualized 3-month rate of consumer inflation is now tracking BELOW the Fed’s 2.0% target). Meanwhile, weekly jobless claims, which had been rising since Spring of this year, dropped both last week and this week. Further, retail sales (which I don’t often comment on) came in much higher than expectations and alleviated concerns that the economy was stalling.
This all leads into the Jackson Hole annual symposium of central bankers at which many now expect the Fed to all but explicitly state a rate cut is coming in September. The Fed can do so because inflation appears well under control and the economy is softening, though importantly, not breaking. Rate cuts at this stage will help build expectations that, indeed, a fabled “soft landing” can be achieved. Accordingly, markets had their best week of the year.
That’s it for tis 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
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