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Once again, August lived up to its well-earned reputation for volatility. Even with a late-month rally, the S&P 500 posted its first monthly decline since February. It’s difficult to point towards the exact catalyst that caused the drop in equity markets, as there were several candidates. Was it the higher move in bond yields? Was it the risk of a slowdown or financial crisis in China? Or was it the increasing odds of a recession in 2024? It may have been a combination of all of those or none of the above. Most likely, after a nice bounce to start the year, the leadership stocks were extended and in need of a reset before their next move.
During the month, we also learned more about the economy’s health as corporations reported their results for the second quarter. Like prior months, they came in ahead of expectations. The fears of an earnings recession are yet to materialize, but at the same time, they aren’t growing either, which shows that for most stocks, the gains this year are only the result of multiple expansion.
One interesting observation from earnings season was that big earnings were not met with higher moves in share prices. This is usually an indication that all the good news has already been reflected in the share price or that there were no incremental buyers left. This is something you would see near the peak of a cycle, not the beginning.
Within the Canadian earnings releases, one concerning factor is around the health of the consumer. Banks and retailers reported that we are seeing more and more signs of interest rates having an impact on credit and beginning to affect the housing market. This has long been a fear for investors, as a leveraged consumer is getting stretched and may be closer to the breaking point. With the Canadian economy showing a negative GDP print for the first time since the COVID crisis, this should be enough of a signal for the Bank of Canada to pause rate hikes for the foreseeable future and put them on a path to begin cutting next year.
Of course, the Canadian market does not operate in isolation, and global factors will remain a threat. Inflation has been slowing over the last few quarters, but at the same time, commodity prices are beginning to recover from earlier selloffs. A contributing factor is the Chinese economy, which has been weaker coming out of lockdowns than anticipated, and their government appears on the verge of launching massive stimulus programs to increase consumer spending. This will only help to keep commodity prices higher, which unfortunately will not help inflation fade further towards the central bankers’ target of 2%.
A slowing economy with high inflation is one of the worst scenarios for economists. It is commonly referred to as “Stagflation,” and if conditions persist, it is becoming closer to the expected future outcome. For investors to protect from this, they must have an allocation towards real assets. This is one of the only ways to remain defensive.
While most market participants have been caught up in the AI hype, it is interesting that commodity sectors seem to be picking up on this and are beginning to act better. While broader markets were negative during August, the energy stocks just showed their third straight month of gains.
The period from August through October is notable due to its history as a difficult time for investors. We are only a third of the way through, so there’s no time to sit back and relax, thinking the worst is behind us now. September will bring additional central bank meetings and more inflation data. Investors are becoming more cautious, and bearish sentiment is growing, which could spark a bounce at any time.
The return of investors from summer vacations will help increase trading volumes for the next few months. Tax-loss selling season is ramping up, and for those who caught the rise of the magnificent seven, it’s time to decide what to do next or wait until next year. So far, 2023 has gone much better than most feared, but it’s not over yet. If there is any window for a stumble, this is the time.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2023 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Macro commentaries” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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