Week of November 7, 2022

Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation

The U.S. is still finalizing its election results. While the House is on track to move to Republican control, the Senate is still too close to call. Nevertheless, the key takeaway from the elections is neither party trounced the other and gridlock is back in vogue. Therefore, expect no major legislation over the next few years as both parties focus on anointing their leaders and honing their message for the next Presidential matchup.

Any new fiscal spending will be contained, which eliminates the risk of stoking more inflation. Since World War II, equities have flourished during post-midterm gridlock as companies like a stable operating environment, and usually get that with a thin political majority.

In other news, U.S. Consumer Price Index headline and core inflation cooled more than expected. This is welcome relief. While we need to see more, it builds the case that inflation is coming off the boil. The details showed improvement across a broad basket. And the market now expects the federal funds rate to peak at a lower rate on the heels of this CPI deceleration.

Source: U.S. Bureau of Labor Statistics, 2022.

Richard Familetti, CFA , Chief Investment Officer, U.S. Total Return Fixed Income

Over the last few weeks several factors have contributed to uncertainty in risk markets. The outcome of the U.S. election is not fully resolved at this writing, but it seems clear that the results will favor a split government. Republicans did not produce as big a win as expected by markets or polls and this seemed to weigh negatively on equities and credit. Upheaval in crypto markets has gotten much worse, but interestingly has had minimal impact on general market sentiment. Earnings were generally below expectations but not enough to dent the overall equity market. Most likely, street earnings forecasts were overstating investor expectations, stemming some of the downward pressure on equity prices.

The week’s slightly lower-than-expected CPI reading drove a massive rally in risk assets. We sense that rate and equity volatility is dropping as we approach year end. Add all this up and we expect risk markets to perform well over the next few months. As a result, we are close to fully invested in credit and structured credit markets.

Source: U.S. Bureau of Labor Statistics, Bloomberg, 2022.

Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management

In the wake of the somewhat encouraging inflation data, equity markets responded positively to the potential for slower rate hikes. However, the universality of the rally in tech stocks, despite the darkening fundamental backdrop there, feels like a classic bear market head fake. Tech layoffs, no doubt the bleeding edge of the spear, are still coming in fast and furious as Meta cut 13% of its workforce of over 87,000 employees, and Amazon announced a cost-cutting review as well in the wake of an earlier hiring freeze.

Fundamental signals at the consumer level are not exactly optimistic, as low-six-figure earners pull back from entry-level luxury purchases like designer belts, financially stressed buy-now-pay-later (BNPL) consumers pull back, and defaults rise in shakier credit products like low-score Federal Housing Administration loans and subprime autos. At the same time, strong equity markets make further interest rate hikes more likely, not less, and core inflation of 6.3% is still a very high number in absolute terms. Overall, slowing rate hikes in the context of continuing increases should be positive for financials and investment grade credit, but the second-derivative impacts of tech layoffs and tightening credit mean that a soft landing is still not guaranteed.

Source: Bloomberg, American Banker, 2022.

Trevor Forbes CFA MFin , Managing Director, Public Fixed Income – Total Returns Portfolio

Canadian bonds are starting to feel more like a crypto currency with yield volatility continuing. Canadian yields dropped like a stone Thursday, moving 20 to 30 basis points down after the lower-than-expected U.S. inflation numbers and comparisons to prior CPI prints had investors beginning to think this could be the beginning of the end of the current tightening cycle. Nevertheless, yield levels are back to where we started at this month, after moving significantly higher earlier in November on positive employment numbers. Corporate bond supply was very robust, even with the shortened bond week and heightened rate volatility. We had one of the busiest corporate supply days since 2015 this week, printing C$6.6 billion and a total C$4.9 billion on Monday alone. As overall supply year to date is still behind last year, the market has been able to absorb this, especially on the long end, with little impact on secondary spreads.

Source: Bloomberg, 2022.

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Steve Morris , Senior Managing Director, Liability Driven Investment

In the wake of the Government of Canada’s decision to cease issuance of real return bonds (RRBs), we’ve spoken to a number of dealers to understand the impact of this move. More broadly, we’ve heard that the overall tone is less liquidity, and anticipate less trading. In some cases, we’ve heard of index fund managers rebalancing their portfolios. Some dealers’ clients commented that if there were distressed sellers, they would be a better buyer. However, there have been no distressed sellers. Overall, it was a very quiet week for trading RRBs.

With the news of the government eliminating RRBs from its funding schedule, we revisited some of our inflation replication research. Our research analyzed a wide range of strategies to replicate Canadian CPI, from using CPIs of other countries, to different commodity baskets, equity indexes and real estate.?In the end, Occam’s razor seems to hold, with a partial exposure to U.S. CPI being a possible alternative for replicating Canadian inflation.

Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.

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