Justwealth 1Q 2023 Market Commentary

Although there were some pretty intense moments, and anxiety levels still feel pretty high, markets actually experienced a very positive start in the first quarter of 2023. Strong gains were realized across all major asset classes, which translated into positive returns for all of Justwealth’s 70+ portfolios to start the year. This should be welcomed news for demoralized investors who are still feeling the sting of the negative market experience from 2022.

Capturing the most significant financial headlines during the quarter was the collapse of two regional US banks (Silicon Valley Bank and Signature Bank) and a rescue of Credit Suisse, a Switzerland-based global bank. The failures were announced within days of each other and sent shock waves through financial markets and caused bond yields to plunge. When the stability of the financial system seems to be at risk, it immediately puts inflation and any other macro issue on the back burner. One only has to look back at the financial crisis of 2008/2009 to see that contagion can spread quickly and have a devastating impact on financial markets, consumers and businesses.

We believe that there are some important takeaways from these failures:

1. These failures should not be unexpected. In central banks’ quest to reign in inflation, slowing the economy is necessary. In a slowing economy, there will be unfortunate financial consequences: markets will drop, companies will fail and unemployment will rise. If these events do not happen, then it is unlikely that inflation will be reduced.
2. There is a natural order in which negative events should transpire after an interest rate hiking cycle: stock markets will fall first since they are forward looking and can price in future economic contraction; “risky” or questionably viable companies will fail as access to credit becomes scarce and poor management or business fundamentals are exposed; leading to increased unemployment and financial hardship for consumers putting further downward pressure on profitability for companies. A rather gloomy cycle.

Indeed, stock markets suffered large losses in the first half of 2022, followed by sharp selloffs of “investments” with questionable merit such as meme stocks and cryptocurrency, and now banks with poor risk management have failed. But, we have not yet hit the final stage of the cycle described above which is reduced employment and hardship for consumers. Employment data is showing modest signs of weakening, but is still near historic highs. Inflation has come down but is still WAY above its intended target range. Central banks still have much work to do, and we believe that the headlines in the financial media will get worse before they get better.

Now for the good news. As we already mentioned, markets are forward looking in nature. It may very well play out that “bad news is good news”, meaning, as soon data emerges that convinces central bankers that the economy needs help, they will, as they always have, come to the rescue. There will be “a turn” from tightening to loosening and that is typically good for both bonds and stocks. The “turn” can happen swiftly and playing guessing games with your portfolio around when that might be is about as dangerous a game as you can play in investing.

Some more good news, …. , kind of. If you might be worried that financial contagion will spread to Canadian banks, think again. We have a banking problem in this country, but not the going-out-of-business kind. Banks dominate the Canadian economy like no other country in the world. Banks currently constitute 4 of the 8 largest publicly traded companies in Canada. Other developed countries will have at most 1 in that same grouping. Government (not party specific) has allowed banks to operate as a monstrous, profit-gouging oligopoly in this country for decades. While that may result in financial extortion on the one hand, it does make the banking business about as secure as it could possibly be for those who need reassurance that the banking system in our country is not at risk.

It takes time for central bank actions to take effect on an economy. If you go back to early 2020 when central banks went all out to stimulate the economy, it took nearly two years of persistence in policy for inflation to emerge as a natural consequence. We are now roughly one year into the tightening cycle, and given our earlier comments about not seeing the final stage to materialize yet, we expect current policies to stay in place for at least a few more quarters, and will look for signs of weakness in employment data, the housing market and personal and commercial bankruptcies as evidence that central banks will once again pivot back to a pro-growth stance.

As always, we preach patience in investing (where possible) as it has always historically rewarded investors.

Here is a recap of market performance as of March 31, 2023*

* Source: Morningstar. Performance annualized for periods greater than 1 year.