David's Weekly - Nov 10, 2023

Plan - don't predict

In this week's letter:

• More signs the rate hike cycle is drawing to a close
• Middle East Update - Keeping an eye on economic risks and a multi-front war
• Most important client questions - the best place to generate yield? It depends

More signs the rate hike cycle is drawing to a close

Finally, payrolls are starting to pay (less)

As we've continued to trudge through what appears to be the end of the big hiking cycle, one sticky element of inflation has been jobs-related. We talked recently about how the economy was effectively in a two-track setup wherein larger, knowledge-based companies were letting staff go while trades-based businesses including housing, and service-industry positions such as travel and leisure were getting harder and more expensive to fill.

Following on the above theme, we can see that U.S. wage growth (orange) is trending down while in Canada it's clear it's peaked but still remains a bit recalcitrant. We're heading the right way, at least for now. That means less pressure to raise rates further.

U.S. wage growth slowing, and Canadian growth stabilizing

We'll quickly review employment which is moving towards a level considered to be ideal both in Canada and the U.S. The blue is Canada, the Orange is the U.S.

U.S. and Canadian employment rates head toward "sustainable levels"

Apologies for the blurred image, but if you squint, you can see employment rates, blue representing the U.S. and orange representing Canada, are normalizing toward the targets (horizontal lines), demonstrating that the fiscal and monetary strategies are flowing through to the job market after some delay. A win for central bankers!

Middle East Update - Keeping an eye on economic risks and a multi-front war

A Quick Summary of Events on the Ground

We'll put aside the political aspects of the war as people can easily draw their own judgments after hopefully filtering carefully through the rash of often rather partisan media coverage. In terms of facts on the ground, there appears to be zero chance of a cease-fire despite pressure on Israel to stop before they're ready.

The military campaign to eliminate Hamas as a "governing" and military organization continues to move forward. The clock is ticking though and while sympathies with Israel provided some initial support by the world, that quickly disappeared, as it always does.

The only feasible conditions for a cease-fire, from the Israeli perspective, are the return of the hostages and the capitulation of Hamas which stated that its goal is perpetual war. Sadly, the destruction in Gaza is enormous and the human cost is tragic with Hamas embedded inside civilian areas, schools, mosques, etc., and Hamas combatants camouflaged in civilian outfits. And, humanitarian corridors are the right thing to do but not perfect.

And ... the market view

As often happens, the most seemingly obvious trade when there is instability -especially Middle Eastern instability - is to buy oil, gold, and the safe-haven USD. Stocks might be a target eventually but only after a significant sell-off.

Back on the trading desk in the early 2000s, we started to learn that terror attacks could cause a significant dip in the market which was smart enough to realize that despite the devastation caused by attacks and responses from that era, the markets typically recovered quickly.

Back to speculating on the Middle East conflict through capital markets: as a short-term strategy, that would have been a one-out-of-three losing proposition. Even with news the conflict plastering the headlines and drawing in the whole world in its usual lightning-rod manner, these markets have so far just shrugged their shoulders. 5-year treasury yields have tightened slightly. The S&P500 initially dipped but is now recovering to where it was on October 7.

DXY (USD Index) has been volatile but sideways - an unneeded safe haven?

NYMEX Crude is actually down significantly from the recent highs - no energy crisis

Gold has firmed up slightly and is rolling over again

S&P500 - back where it started at the beginning of the conflict

Between the war in Ukraine and a multi-front Middle Eastern war, the world is on edge. All we can say is that trading these kinds of shorter-term events is hard and that it is best to keep your eyes on the horizon, even when the world seems on the precipice.

When investing, best to keep your eyes on the horizon and avoid shorter-term noise

Most important client questions - the best place to generate yield? It depends ...

In the current backdrop, investors have an impressive range of interest-generating, lower-risk options to compete with dividend yields. That's not news. In fact, when everyone knows the same thing about the market, often the opportunity is closer to the end than the beginning.

As an aside, it's always going to be hard for bonds to compete with inflation as bonds max out at their par value regardless of how much inflation runs.

Stocks can, of course, can and do compete with inflation as their upside is unlimited. (Their downside is limited to zero.) That is why, over the longer term, stocks have the potential in the future and a long track record in the past of helping retirement portfolios protect purchasing power in the future.

So much yield, how to choose?

U.S. Treasury Yield - not much difference in returns all across maturities

A diversified Canadian bond portfolio can yield roughly 4.5%. That portfolio would own shorter - up to 5 years - and longer-term - up to 30 years - Corporate and Government bonds. With the exception of high-yield bonds which are sub-investment grade, the difference in yield between all of the individual bonds in a diversified portfolio is only roughly /- 0.5% about the average of about 4.5%. (Keep in mind that the bond market is volatile and these numbers change frequently but not drastically.)

So, how do we choose?

The real work comes from constructing the portfolio to suit an investor's individual needs and goals. The golden rule of thumb, if there is one, is the following:

• only invest in bonds whose maturity date occurs BEFORE the time horizon of the portfolio itself.

It would be unrealistic to do justice to the full spectrum of thinking going into a bond portfolio in a brief section of a letter, but we'd be more than happy to have a discussion with you about your personal goals and how a bespoke bond portfolio will help you achieve those goals. But here are the most common goals we're reviewing as they pertain to financial plans and related portfolios

• purchase of a home or cottage
• covering higher interest expenses
• sending children to post-secondary school
• pre-funding a trust for a cause or family member
• creating a nest egg for retirement

To discuss solutions to achieve your own goals, please get in touch.

[email protected]

And with that, we'll wrap as always with this week's global insight. Enjoy.

In this week's issue...

• Earnings update: Questions remain about 2024: S&P 500 earnings are on pace to break back into growth territory after three quarters of declines, and the recent equity rally may seem like icing on the cake. But beneath the surface, uncertainty about the future direction of the U.S. economy continues to swirl.
• Regional developments: Canada’s trade surplus more than doubles; U.S. fixed income performance amid the strong pullback in borrowing costs; UK markets anticipate interest rate cuts; China slides into deflation again.

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