Ally Pyle
December 22, 2022
Oh, Oh, Oh
If we compared the traditional wishes sent up by those desiring a white Christmas with earnings estimates by stock analysts, then it’s safe to say that the results beat expectations. Seriously though, the winter storm that is gripping so many parts of North America is going to disrupt many a holiday travel plan. We do hope that you and your loved ones are safe as we head into the weekend.
Traditionally, the newsletter before Christmas was the last one of the year and that tradition will hold this week. Before I begin, however, I want to officially introduce to you the newest member of the Pyle Group and that is Michelle McMillan. Michelle will be working with Tammy and Hayley to further enhance the client experience that has been at the center of what we do. She comes with several years’ experience at CIBC. Please join me in welcoming her aboard.
By the end of last December, the S&P500 had just chalked up a gain of over 27% for 2021 – an impressive feat considering that we were still in the throes of a pandemic and started the year with an insurrection on the US Capital. Market participants were not necessarily looking for a repeat in 2022 and certainly saw some headwinds on the horizon, but didn’t believe that we would see more than 20% knocked off the S&P by year-end. Even though the index is above its lows from October, at 3770, it is finishing up at levels that we saw in March 2021 and with a lot less optimism. The TSX did fare better, though still went in a direction few had expected. After more than a 20% rally in 2021, the index is now down only 9% this year, though the loss was as bad as 14% back in October.
The miss on the equity call this time last year is still nothing compared to what happened to the bond market. In Bloomberg’s December 2021 survey of the major investment shops, yields were a fraction of where they are today. The 2yr US treasury was trading at around 0.7%, the 5yr was at 1.25%, the 10yr was close to 1.5% and the 30yr long bond was still south of 2%. It wasn’t that economists and traders didn’t think rates were going up – the lowest prediction on the 2yr for the end of 2022 was 1% and the low for the 30yr was 2.05%.
At this time of year, the business media is usually jammed with reviews of the past 12 months and forecasts of what is to come in the new year. While economic and financial outlooks do serve a purpose in terms of business and household planning, many of you will likely agree that last year’s set of projections were about as far from a preview of reality as you can get.
By the end of last December, the S&P500 had just chalked up a gain of over 27% for 2021 – an impressive feat considering that we were still in the throes of a pandemic and started the year with an insurrection on the US Capital. Market participants were not necessarily looking for a repeat in 2022 and certainly saw some headwinds on the horizon, but didn’t believe that we would see more than 20% knocked off the S&P by year-end. Even though the index is above its lows from October, at 3770, it is finishing up at levels that we saw in March 2021 and with a lot less optimism. The TSX did fare better, though still went in a direction few had expected. After more than a 20% rally in 2021, the index is now down only 9% this year, though the loss was as bad as 14% back in October.
The miss on the equity call this time last year is still nothing compared to what happened to the bond market. In Bloomberg’s December 2021 survey of the major investment shops, yields were a fraction of where they are today. The 2yr US treasury was trading at around 0.7%, the 5yr was at 1.25%, the 10yr was close to 1.5% and the 30yr long bond was still south of 2%. It wasn’t that economists and traders didn’t think rates were going up – the lowest prediction on the 2yr for the end of 2022 was 1% and the low for the 30yr was 2.05%.
No one was predicting aggressive Federal Reserve action and no one was forecasting an inverted yield curve. Today, the 2yr is close to 4.25% and the 30yr is sitting at 3.7% for an inversion of over half a percentage point, though still not as bad as the almost 0.9% spread back in the first week of this month. This was the most inverted we had seen the US yield curve since the early 1980s. No surprise then that economists are a little gun shy on economic growth for next year, versus where their projections were this time last year.
In the December 2021 survey, US real GDP growth (annualized) was supposed to remain above 3% at least until the end of 2022, before moderating down to the 2.5% neighbourhood. We ended up seeing contractions of 1.6% in Q1 and 0.6%, before a rebound to 3.2% in the third quarter. Well, at least they got that quarter right. Today’s survey reads a little differently. GDP growth is forecast to moderate to 1.1% in the current quarter, hit zero in Q1 and then turn negative in Q2. It is then expected to remain below 2% all the way out to the second half of 2024. Note, consumer spending growth is not anticipated to become negative at all throughout the forecast time horizon. I know there have been a handful of indicators recently that suggest a resilient US economy; however, given the shape of the yield curve and the near-certainty that the Federal Reserve will keep raising rates next quarter, I think economists are about to be too high on their estimates yet again.
What then of inflation? Well, a year ago, the survey did see CPI inflation accelerating to 6.6% by the end of 2022, but then the consensus call was for a deceleration to below 5% by the summer and a drop to below 3% this month. Ah, how wonderous that would have been for J. Powell and the FOMC. Instead, inflation climbed to well above 8% by the summer of this year and it was sitting at 7.1% in November. Has this humbled the group of forecasters this time around? You bet. Inflation is expected to remain above 3% until the fourth quarter of 2023. By the end of the first half in 2024, inflation is seen coming in at 2.6% - still a decent amount above the Fed’s target.
Embedded in these new predictions is a realization that, while economic softening has led to deflation in some goods categories, there is still underlying pressure in services and wages. And this is why markets stumbled from their early Santa Claus rally and are struggling into the holiday weekend. The current interest rate forecast survey shows a US 2yr yield holding above 4% until this time next year. The 10r is expected to basically hover near current levels around 3.6%. For Canada, the 2yr is expected to trade above 3.5% until the second half of the year and then rally down around 3.25% a year from now. The big difference between US and Canadian forecasts is that the Fed is expected to add another half a percent to its current overnight target of 4.5%, while the Bank of Canada call doesn’t even have a full quarter-point tacked on to the current 4.25% target. I would suggest the Bank is going to be wary of letting the forecast stick, at least in terms of the spread, given the hit this could represent to the Canadian dollar.
The list of unexpected developments is indeed long, including the 70% plunge in Bitcoin, the 65% decline Tesla shares (or that Musk would end up buying Twitter, thus providing even more drama and entertainment to end the year), or even the 50% drop in Amazon shares. Crude oil was not expected to reach $100 a barrel, let alone spike to $130; but when it did, all the folks on one side of the boat didn’t think it was going to dive to $70 before year end either.
Again, as much as December prognosticating might seem a waste of time, it is still useful. I echo the views of many economists and strategists, that economic conditions are likely to get worse before they get better. That said, I also believe that we have seen the bulk of the bad news on interest rates and bond market performance. In addition, if the North American economy is sinking into a recession, I expect this to be relatively short-lived. That doesn’t mean it will necessarily be shallow, but we should be coming out of it well before the end of 2023. Rates should also be heading lower around that time.
Of course, it’s not all about how the economy and markets fared this past year, compared to what was predicted. We didn’t expect that Russian would have invaded Ukraine and, even when the war started, very few believed that the war would still be raging today, nor that Ukraine’s President would give an in-person speech to Congress. We also never would have thought that COVID would yet remain as much a threat today, nor that other illnesses would emerge. We also know that financial struggles for many are just beginning to show up, as households deal with declining property values and elevated mortgage and credit card costs.
We have all been through a traumatic year, just when it looked like the clouds were parting on the pandemic-induced anxiety of 2020. Ally and I have been doing our rounds these past weeks to try to lend some support to charities and agencies in need, knowing that this will only scratch the surface. We are definitely going to be doing a lot of reflection over the holidays and lend a hand and hope to those who need it.
On behalf of the Pyle Group, happy holidays and we will see you in the New Year.
Andrew Pyle
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These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.