Andrew Pyle
December 22, 2023
Preparing for the winter
Yesterday was the winter solstice, when our Northern Hemisphere leans as far away from the sun as it gets during the year. As I pen the last commentary of 2023, I am looking down at a tree that has its roots, literally, in the tradition formed from ancient celebrations of this day. While the days do get longer from here, they also get colder in these climates. After the heatwave experienced in both equities and bonds these past two months, some are wondering if the chill is about to set in.
I discussed in our last conference call of the year how a great deal of optimism has been priced into markets in recent weeks. Not only has there been a pivot by the Federal Reserve towards a perceived certainty of rate cuts next year, but talk of a recession has all by vanished from the year-end research reports pumped out of Wall Street. Market participants now seem quite comfortable talking about six rate cuts next year, which implies that the Federal Reserve will lower rates in six of the eight scheduled meetings.
While the S&P500 still struggles to make a brand new record high (4818 at the start of 2022), this is still the eighth consecutive week of gains for the index. We would have to go back to the first week of November 2017 to find the last time such a string was put together. Then, there was a two-week pause before the rally continued with five more straight weekly gains into the third week of December. Again, another one-week breather, followed by four straight weeks of lift in January. After that, the year was really just a struggle against the backdrop of rate increases and trade wars. It would be a year later that we would see real signs of economic fatigue in North America and then a year later still before the pandemic.
There were few calls for recession at the end of 2017 and, even though the market’s assessed probability of recession next year has declined, it is still statistically significant. For example, this time last year, economists surveyed by Bloomberg placed a 70% probability of recession in 2023, while today the probability for 2024 is 50%. Canada was also assigned a 70% probability last year and is now 55% for one taking place in 2024. In other words, we have gone from a situation in December of last year, where there was extreme pessimism to one today, where the going view is that a gentle slowdown or soft landing will prevail.
As many of you know, we have taken steps to lower risk into year-end – not because we have become extremely bearish, but out of recognition that there are still sizable risks in 2024. We have drawn comparisons to the summer of 2020 when the market had spiked following the massive valuation meltdown from the pandemic in February-March. That was also an election year and by August it appeared to Ally and I that equity markets had become disassociated with fundamentals. It prompted us to trim back exposure and move to cash.
What we have seen in the last eight weeks is minor compared to back then. The TSX vaulted more than 50% from the trough in March 2020 to August (or 159% on an annualized basis), while the index has climbed just around 12% since the lows this past October (annualized rise of 112%). That doesn’t mean we don’t take some precautions to lock in growth seen during this period. As I mentioned on the call, we think the outlook for 2024 is fairly positive. Even though I disagree with the extent of central bank easing priced into the curve and stocks, I do believe we will get a few rate cuts. I also believe that inflation will continue to move lower, though perhaps not as fast as some may think. Both bonds and stocks do need to re-evaluate the outlook for rates, especially in an election year.
On last week’s call, we talked about the Bloomberg consensus economic forecasts that are published regularly, with data from their surveys of market economists. This time last year, the consensus called for 2024 U.S. real GDP growth was 1.3%. The street back then was quite pessimistic, if you recall, on the basis of what might happen after the aggressive move higher in rates. That pessimism grew to the point where in August, the consensus view was for only 0.6% growth next year. Fast forward to today and guess where the average prediction is? You guessed it, 1.3%.
An economist that I used to work with back in a previous career, Steven Ricchiuto (now the chief economist at Mizuho Securities), provided an excellent observation this week. In speaking with companies across the U.S., he said that most of them had the same message. They were doing fine, but they saw the economy around them as weak. If you talk to enough executives across sectors and they are saying things for them are good, then either the macro environment around them isn’t as weak as they say, or there may be more to the story. This potential cognitive dissonance is likely to play out in the weeks and months to come and while it may not result in a sharp pullback in stock valuations, it could result in higher volatility and better opportunities for us to re-deploy cash.
Well, as has been tradition for us at this time of year, we like to conclude the final newsletter with a parodied version of a classic holiday song. As my son Luke loves this old cartoon and the Frozen character, Olaf, I thought this one appropriate.
Frosty the trader was a jolly bullish soul
With an old top hat and a strategy,
and a calculator bought from Kohl’s
Frosty the trader always knew when to buy and sell
After higher rates and an AI craze,
he played the market swell
There must have been some magic in that
last CPI report they found
For when the Fed officials met
they guided interest rates down
Frosty the trader
in the market he did roam
Buying here and there
hedging everywhere
With a focus like Jerome
He hopped into the market, finding gains and lots of glee
and he only paused a moment
When the RSIs said “stop”
For Frosty the trader
had to hurry to the mall
So he said sold his SPYs
saying don’t you buy
They’ll be cheaper again some day
On behalf of the Pyle Wealth Advisory team, I want to wish all of you a merry holiday season, filled with love, laughter and, beyond all, peace. May the coming year find you and your family and friends healthy and happy. We will see you all in the New Year.
Andrew Pyle
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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. He and his clients may own securities mentioned in this column. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.