The key to making money in stocks is to not get scared out of them.”

– Peter Lynch

Hey ChatGPT, Tell Me Whether a Recession is Coming in 2023

“As an AI language model, I lack certainty in predicting future events like recessions. Economic forecasts involve various factors and are complex, making accurate predictions challenging. Even experts can have different opinions and struggle to consistently predict recessions.”

Well said!

Stocks have made a dramatic comeback from their 2022 slump, with tech stocks leading the charge on the back of high hopes around generative AI, which includes the likes of ChatGPT’s impressively human-like chatbot and other art and music-generating platforms. Progress has also been made on rising prices, with Consumer Price Index (CPI) inflation cooling to 3.4 per cent in Canada and 3.0 per cent year-over-year in the US for May and June, respectively, their lowest levels in two years. Inflation has proven sticker elsewhere, with the Euro Zone experiencing a rate of 5.5 per cent in June, but that has not stopped investors from pushing CNN’s Fear & Greed Index into “extreme greed” territory.

It is a stark contrast to a few months ago, when the US saw its second largest bank failure in history…twice. A combination of higher rates, unprecedented bank runs ($42 billion was withdrawn on March 9th alone), and poor risk management (the banks held primarily long-duration bonds that fall in value as rates rise) caused first Silicon Valley Bank, then First Republic Bank, to fail. Regulators promptly took over the institutions, sold the assets, and guaranteed otherwise-uninsured deposits, but with Switzerland likewise seeing the collapse of Credit Suisse, a Global Systemically Important Bank, in March, many feared a global banking crisis was coming.

That thankfully never materialized, but challenges do remain. Households, businesses, and governments, some of which currently hold record-levels of debt, will have a difficult time accommodating higher interest payments, and with the yield curve inverted, global trade and manufacturing slowing, and the War in Ukraine passing its 500-day milestone, the calls for a recession, albeit ever persistent these past two years, are growing louder.

Nonetheless, much like ChatGPT, we cannot know what the rest of 2023 holds. What we do know is that markets, while reactionary to headlines and short-term headwinds, do normalize over time. You need not look further than 2020…or 2021…or 2022, for an example.

As always, we thank you for your support and continued confidence in WDS.

Equities

It has been a middling first-half for Canadian markets, with the S&P/TSX Composite Index ($TSX) up 4.0 per cent (5.7 per cent after dividends) as of June end. Information Technology, while a small constituent of the index in Canada, was a clear outlier, surging 47.4 per cent (excluding dividends), recovering a good chunk of its 2022 lost ground. The next-best performing sector, Consumer Discretionary, saw a 10.1 per cent return, while the worst performing sector, Energy, dropped 4.9 per cent. The stock market recovery in Canada has not been as rapid as peers, but with first-quarter GDP growth coming in at 3.1 per cent annualized, the country’s economic performance has surpassed expectations. Strong immigration likely contributed; the country surpassed 40,000,000 Canadians in June.

The surge in tech positions has benefited the US, with the S&P 500 Index ($SPX) up 16.9 per cent (inclusive of dividends). In Canadian dollar terms the total return was 14.2 per cent thanks to the marginal weakening of the US dollar. This growth is almost exclusively thanks to the IT and communications sectors, despite these areas only accounting for a third of the S&P 500’s market capitalization.

Outside of North America, the MSCI EAFE Index ($MSEAFE) saw a year-to-date total return of 11.7 per cent despite the continuing drag of the war in Ukraine. The return has been driven more so by expanding valuations than improving earnings growth, with manufacturing activity contracting and the Eurozone entering a technical recession in the first quarter.

Fixed Income and Interest Rates

While the Bank of Canada paused its rate hikes briefly after the 25-basis point hike in January, stronger-than-expected economic data seems to have convinced policymakers that more work is to be done. The policy rate was hiked a second time this year in June to 4.75 per cent, with the rate currently at 5.00 per cent following a third hike at the time of writing. The central bank is further continuing its quantitative tightening program, which has reduced its balance sheet size by roughly a quarter this year in an attempt to increase longer-term interest rates. Concerns remain around whether Canadian households can absorb the rising costs of debt – while delinquencies have so far remained stable, the Financial Consumer Agency of Canada estimates that two-thirds of mortgage holders are struggling to meet financial obligations.

Despite the rising rates, bond prices managed to appreciate, with the FTSE TMX Canada Universe Bond Composite Index increasing 2.4 per cent year-to-date. This may signal that markets believe central banks will eventually reverse course on their interest rate hikes, this despite messaging to the opposite effect from Bank of Canada Governor Tiff Macklem.

Meanwhile, the Federal Reserve appears to be pausing its own contractionary policy…for now. The federal funds target range has been hiked three times in 2023 to 5.00 – 5.25 per cent. Even with inflation approaching its 2 per cent target, Federal Reserve Chair Jerome Powell has guided for further action. Additional hikes would further steepen the already-inverted yield curve (short-term bonds yielding more than longer-term securities), something viewed by economists as a recession indicator.

Currencies

The Canadian dollar ($CDW) ended the first half of 2022 at $0.76 USD, up 2.4 per cent year-to-date. Inflation has decelerated meaningfully in the country, coming in at just 3.4 per cent for the month of May, while at the same time economic performance has been stronger than expected - the country saw a 0.3 per cent monthly increase in employment this June, even as unemployment ticked higher to 5.4 per cent. Still, the country experienced its largest trade deficit ($3.4 billion) since October of 2020 in May, and real consumption per capita remains well below that of the US, with much of the economic performance being thanks to higher immigration.

2023 Inflation in the US has cooled meaningfully as well, coming in at just 3.0 per cent for June, down from its 9.1 per cent peak this time last year. While the US dollar index has fallen only marginally, it was a volatile year for the greenback - the collapse of several regional banks early this year provided a temporary boost (bank crises are deflationary) before regulators stepped in to cover at-risk deposits.

Commodities

Trade conditions have continued to normalize in 2023, with the average global freight rate reaching ~$1,500 USD in June, down ~85 per cent from its high in September of 2021. Commodity prices have moved lower too, with the West Texas Intermediate ($WTIC) ending June at $70.64 USD, a drop of 12.0 per cent year-to-date, this despite multiple production cut announcements from OPEC. While supply chain recoveries play a role here, the falling price likewise reflects market speculation that a recession is on the horizon, something that would lower demand for energy.

In tune with this sentiment, gold ($GOLD) ended the first half of the year at $1,916.00, up 5.5 per cent, temporarily surpassing $2,000 earlier this year before settling lower. Concerns of a recession may not be the only thing supporting gold’s price – reports indicate that Brazil, Russia, India, China and South Africa (collectively the “BRICS” nations) are preparing to announce a gold-backed trading currency in August. While a clear challenge of the US dollar’s dominance, economists question the feasibility of a BRICS common currency, including Jim O’Neill, the man who coined the acronym in 2001.

This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.