After a generally positive summer, in comparison to the first half of the year, markets are once again neck-deep in uncertainty. Where investors had a sense of optimism that the North American economy could avoid recession, while providing a disinflationary environment that would lower the odds of continued aggressive tightening by central banks, that conviction began to fade ahead of today’s Federal Reserve Jackson Hole forum.

 

As of August 16^th, the S&P500 had rallied more than 17% from its low in mid-June. This represented more than a 50% recovery of the ground lost since the start of the year and exceeded the 61.8% retracement mark of the March-June correction. Since last week’s high, the index has moderated back below 4200, yet had not shifted outside its positive technical pattern of higher lows – at least for now. Some of this latest retreat has coincided with a less constructive tone in the bond market. As the chart below illustrates, the S&P and US long-bond future had been moving in tandem since the beginning of the year, but that positive correlation has broken this month.

 

A similar development has taken place north of the border, where the Government of Canada 10yr bond future has broken appreciably lower in the last couple of weeks. The fact we have seen this divergence in both countries is not shocking since we typically expect stocks and government bonds to move in opposite directions. That is usually more pronounced in times of recession, when central banks are cutting rates amidst weakness in corporate performance. Vice versa, when the economy is in expansion mode and rates are being pushed higher to fight inflation, bond prices will slip as stocks move up.

 

The situation we are in now cannot be defined as being somewhere in the middle. Inflation is still high, but economic numbers are deteriorating, yet central banks are still wedded to the plan of hiking rates to bring price pressures under control. This past month has seen its share of bad data, especially in the housing market and manufacturing. Still, those indicators that reflect the health of the consumer (which is the dominant segment of both economies) have come in fairly robust. Take US jobs and retail sales, for example.  The July payrolls report blew economist predictions off their hinges and while July sales definitely moderated from June, the headline numbers came in above expectations.

 

Anecdotal evidence does suggest that employment conditions are starting to moderate as a growing number of companies announce job cuts in order to preserve margins amidst rising input costs. The number of job openings in the US do look like they have hit a peak, after soaring through 2021 and the first quarter of this year. We get the second quarter report next Tuesday, but the level in the first quarter was already back this time last year. At the same time, firings are accelerating, as witnessed by the data from the Challenger, Gray and Christmas job cuts data. For the month of July, layoffs had edged lower from June, but are still up 36% from the same period in 2021 and I would suspect that August will see another increase.

 

If employment conditions at the margin are deteriorating, home prices are slipping and consumer confidence is lower, how is the spending picture not getting materially worse. After all, government handouts are pretty much over and savings that were built up during the lockdown are gradually declining. The answer is that consumers are funding a greater amount of their purchases with credit. The chart above shows the monthly changes in US consumer credit over the last half a century. The previous record was just over $28 billion back in 2016, just before interest started to climb.  In March of this year, credit grew by $47 billion and, after a temporary pullback in the early part of the second quarter, it jumped by $40 billion in June. The July figures will come out on September 8^th – a little under two weeks before the Federal Reserve’s next policy meeting.

 

Which brings us to this morning’s comments at Jackson Hole by Fed Chair J. Powell. After shifting from a hands-off approach to rising inflation last year to a gradualist approach in the Spring, the Fed (and Bank of Canada) hit the accelerator in the summer to a more aggressive pace of rate hikes. Powell reiterated the need to get inflation under control this morning and emphasized the risks of not stabilizing prices.  As much as inflation looks to have bent in July (including today’s personal consumption deflator figures), Powell kept hitting on the point that now is not the time to relax efforts to getting inflation down. The remarks definitely reinforce views that the Fed will deliver another large hike at the September FOMC meeting. The fact that he was outright in his comment that there will be some economic pain involved in achieving price stability does suggest that a pause to hiking won’t happen in the fourth quarter.

 

None of this is particularly shocking and investors were guessing that Powell’s remarks would be on the hawkish side, but as market participants digest the future direction of policy stocks probably will be flat.  This is why Ally and I have made the adjustments to the portfolio that we have in the last week or so, building cash levels modestly and allocating more to higher income producing vehicles. We still believe that the decline in inflation will be steeper than what bears expect, but caution is warranted.

 

Have a great weekend everyone

Andrew Pyle

 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc. “CIBC Private Wealth” is a registered trademark of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2022.CIBC Wood Gundy, a division of CIBC World Markets Inc.

 

These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.