First and foremost, a very Happy New Year to all of you from the Pyle Group and all our CIBC partners. On behalf of everyone, I hope you and your families and loved ones have a truly healthy, joyful and prosperous 2023. Since the start of the pandemic, I’m not sure if there has been a year that we weren’t actually happy to see put behind us, but 2022 definitely stands out as one. Yet, the ringing in of a new year doesn’t act like a light switch, where problems of the past immediately disappear, to be replaced with more positive outcomes. Perhaps we can hope for at least a dimmer switch as we enter this year.

 

On the healthcare front, things definitely feel better than a year ago even though we are far from being out of the woods. This time last year, the omicron variant was filling the headlines and new daily covid cases worldwide were close to 4 million. Today, cases are down well below a million.  In Canada, daily new cases were up around 40,000 in January 2022 and are now down to just over 2,000. Comparisons are fairly irrelevant though, given that official testing has gone way down (home testing though is probably multiples above last years' experience). That said, we now have to get used to another variant name (Kraken) and the same questions we had before – is its severity going to be as intense as its transmissibility? 

 

What is clear is that the anticipated economic and market impact from covid continues to fade back into the shadows – dwarfed by more fundamental drivers, like inflation, interest rates and geopolitical developments. The start of 2023 is markedly different on all scores, compared to last January. In Canada, we had just seen a 4.7% print for CPI inflation and 6.8% in the US. Today, we are working off a 6.8% rate for Canada and 7.1% for the US. The magnitudes are higher, but the vectors are different.

 

 

 

 

Canada’s 6.8% pace is down 1.3% from last summer’s high, yet the 4.7% rate of inflation that we saw coming into 2022 was a gain of 1.6% from the summer and a rise of almost 4% since the start of 2021. The US has seen inflation decline 2% from its peak of 9% last June, while the 6.8% rate we were dealing with this time last year was a gain of 1.4% from the summer (and more than 5% higher than where it started 2021 off at).

 

Interest rates and bond yields tell a similar story. Canada’s 2yr government bond yield was 1% this time last year – five times where it was at the start of 2022. Today, it trades at 4% - a relatively smaller percentage gain – and it has been in decline since its peak near 4.30% in October. Ditto for the US, but while the percentage increases in yields this past year have been less, that is not a silver lining whatsoever for businesses and consumers. Borrowing costs have now risen to punitive levels and this is why we are talking so unreservedly about recession in 2023, where 2022 was seen as perhaps just feeling the odd headwind.

 

 

 

Okay, so it looks like inflation is in retreat from excessively high levels and interest rates are likely to rise by much more in 2023. None of this speaks to the great unknown and that is the direction that corporate earnings will take this year and how the stock market is priced. Stocks have lost ground in the first few trading sessions of the new year, with the S&P500 off 0.8% as of Thursday’s close. That’s still a bit better than the 1.4% loss in the same period a year ago. Here at home, the TSX was actually up 0.6% as of Thursday, compared to a 0.9% loss in the same opening days of last year.

 

Some investors will look at the first week of January as a leading indicator of what is to come for the year overall and, based on what we have seen so far, the outlook isn’t particularly positive for the US, even though Canada doesn’t look too bad. The more relevant indicator for some is what is referred to as the January effect and this is where we use the performance of equities over the entire month as a gauge to what could happen by the end of the year.

 

In the US, equities had a rough January last year. The S&P500 lost 5.3% and the Dow Jones was off 3.3%. By the close of business on December 30^th, the S&P was down 19.4% and the Dow had fallen 8.8%. Last year, the TSX finished with a similar decline of 8.7% after experiencing a very modest hit of 0.6% in January overall. While the TSX outperformed for most of 2022, thanks in part to commodities, the relative outcome for the year compared to its January performance was disproportionately negative.

 

 

 

Some are speculating that the January effect for both Canada and the US will be positive this year, despite concerns over recession and further tightening by the respective central banks. The reasoning is that the January 2022 slide in stocks came after a huge run-up in the previous year and a strong Santa Clause rally in December. In other words, what went up was destined to go down. This time around, we are coming off a rather dismal 2022 and a truant Santa Claus. This would suggest that January has nowhere to go but up, therefore painting a rosier picture for 2023.

 

If we go back to 1960 and analyze years where we had a positive versus negative January, in relation to how a particular market index performed over the course of the year, the odds certainly favour this outcome. In the case of the Dow Jones, we have seen 38 years where the index gained in January, against 25 where there was a decline. In 87% of those positive January years, the Dow closed higher at the end of the year. This margin is even greater than where we saw a negative January, followed by a drop over the course of the year (56% of the time). In other words, in 44% of those years where the Dow started the year off shaky, the index still closed up on the year.

 

 

Results for the S&P500 are even stronger, with a positive January coinciding with a gain on the year 90% of the time. In terms of the TSX, the historical correlation between a good January and winning year is a little weaker at 74%, but that is still much higher than the observation of how many times we ended the year down on a bad January (42%).

 

As tempting as it might be to wager with the bulls, should stocks end January upbeat, we need to be cautious of how weakening economic conditions over the course of the year can counter any early optimism. In 2018, for example, the Dow jumped 5.8% in January, following a massive 25% rally in the previous year on Trump tax cut optimism. Interest rates, which had started to rise in 2017, continued to climb in 2018 alongside trade frictions between Washington and its major trading partners. The result was a growth and earnings slowdown, with stocks becoming more volatile and the Dow finishing the year off more than 5%.

 

I’m not suggesting that a similar outcome is going to transpire in 2023. It is entirely possible that we still end the year higher than where we closed last month, even if January turns out to be negative. Where I do think we will see a similarity is in volatility, at least during the first half. This will depend on soon central banks begin to signal an intent to switch gears from tightening to easing. If you remember from 2018, the heaviest selling pressure on stocks took place in the last quarter of that year. The mood of the market became intensely sour – right before a bounce in January 2019, and a gain for that year of 22%. Even more reason, in our opinion, to keep some powder dry as we work through the remaining three weeks of this month.

 

On behalf of the Pyle Group, have a wonderful weekend.   

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.