Ashleay: Hi, my name is Ashleay and welcome to part two of the 2022 recap. By the way, if you haven't already done so, I invite you to listen to our first part available on all platforms. Still with Sébastien Mc Mahon and Marc Gagnon, we continue our review of the year. So, Marc, Sébastien, hello again.
Sébastien: Hello, Ashleay.
Marc: Hello, Ashleay.
Ashleay: So, can we maybe talk about the elephant in the room that has been mentioned a number of times all over the news? It is the “R” word. So, the recession.
Sébastien: Yes, sure. So, 2022, we avoided the recession. We did talk about recessions quite a bit. And in fact, in the U.S., we started the year with first quarter, second quarter of negative growth, which when I was at university, I mean, this is how they taught us that that was the definition of a recession. But now it turns out that there's a committee, it's the NBER committee in the U.S. that decides when there's a recession. They look at, you know, employment spending, industrial production and all of that. And it seems that the conditions were not enough to say that there was a recession in 2022 in the U.S. In Canada, the economy actually was pretty solid, starting to show some signs of weakness as we're getting late in the year, especially when you look at the domestic side of things. But when you look forward to 2023, then the question, you know, it begs the question, where will growth come from? It's hard to see it. And we still think the odds of a recession are about 70% to 80%, both in Canada and in the U.S.
Marc: Yeah, I agree that recession is probably coming. And you know what? That's probably what we need to see at one point, you know, inflation to comes down. One thing I think though, it's not going to be a too severe one or a too deep one. Why? For one, I think that the labour market, as we know, is pretty strong. We know that people, there's a lot of job openings right now still. It's coming down a bit though, which is what we need to see. But what will happen is someone will be probably less afraid to lose his job or even if he lose it, to not find another one. So, then people continue to consume because, you know, it's not like, oh, I might be six months out of job, three months out of job. I have to save. I have to be quiet in terms of buying stuff. So, I think the consumer will continue to support in a decreasing way the economy, but not to the point that it will stop everything. And I think that at the end of the day, that's good because it's not about, inflation is not about having a job, it's about compensation, how fast your compensation is growing. So, we have to separate the two, you know, like we have to hope that people will keep their job, but not with a too high, you know, compensation package like rising, you know, salary like 5%, 6%, 7%. We need more 3% to 4%. That's what we need, I think for the next couple of months, at least 12 to 18 months.
Sébastien: So, the economy won't fall off a cliff, but a soft patch, of course. But you're right that, you know, if salaries continue to rise at such a hard pace, it's going to make the job of central banks even harder. That could push the recession to being even deeper down the road.
Marc: Yeah, that's the thing. I think they won't stop, you know, they won't lower interest rates anytime soon. And they might even keep increasing it for a while if they don't see, you know, salary and compensation fall back a bit. So, that's the negative side of the recession. But having a recession where people are not too afraid to lose their job, it's going to be better than usual, on the other hand. So, yeah.
Ashleay: And all of this, if I understand correctly, is linked to what the Bank of Canada and the global central banks are doing, that is raising interest rates at a pace that seems historical. Right?
Sébastien: Yeah, yeah, exactly. I mean, it's kind of hard to know where to place central banks in this conversation because it's kind of everywhere. But you know, what we just discussed here, that we have the economy slowing down, of course it is a result of central banks fighting inflation. And to fight inflation, you need to curb growth. So, that means that you need to slow the economy down. And usually you see the central banks, they slow it down a bit too much and you have a recession at the end. So, recession, of course, 2020 was a global pandemic. 2008 was a great financial crisis. 2000 was the bursting of the dotcom bubble. So, it's not like we're talking about these big types of recessions, but central banks, they had to fight inflation. They had to wait a little bit because, yes, inflation was at 5% in January 2022. Central banks still waited a little bit because we still had restrictions for COVID in January. The job picture was very negative in Canada in January. They needed to see that alright, the job market is rebounding, and the next date was March. But you know, at that time, early this year, central banks had both feet on the gas just stimulating the economy. They had to remove both feet, move them to the brakes and apply both feet to the brakes. So, that leads us to late 2022 and this is where we're at now. Now the question is how long will they keep both feet on the brakes? That's the question that's going to determine how the markets behave.
Marc: One million dollar question that we’re all asking ourselves. Some people, though, are a bit you know, they're not really happy with the fact that the central banks took a bit too long before starting to put the brakes on. But you have, as we said, the last episode of that podcast, we have to remember that the war in Ukraine was unforeseen, and that really added fuel to the fire. And I think that's what got the central banks a bit behind the ball. They had to adjust and now I think they’re back on top, which was not the case maybe three, six months ago. They're there. I think they're holding the thing right in their hand. But they have to wait for the fire to calm down, the fire being the inflation. So, it will take some time. Some people don't think that the risk is that the recession, the economy can suffer more than expected. So, but hey, there's always a good side on everything then, I mean, the pivot will come a little faster.
Sébastien: Yeah. But one thing that we learned for sure this year and actually we did a podcast on this topic, monetary policy and fiscal policy, they need to work hand in hand, not one against the other. What we learned from the UK, I mean, you have the central bank, the Bank of England, that was putting the brakes on the economy and the government decided to borrow, to spend and to cut the taxes on the rich to stimulate the economy. And you know, Mrs. Trust, she lasted 44 days before what we call the bond vigilantes coming. And, you know, just, you know, saying, all right, we don't want none of your bonds. Interest rates rise, pension funds having some issues, and you have to unwind all of that. So, likely no one, no other country will be tempted to play that game in 2023.
Marc: Yeah, the warning from Bond Village, Ireland was severe. It was spectacular. And I think that every government around the world took notice that markets are there and they're watching them if they do silly thing like cutting cutting taxes for the rich. I think though, that with the kind of inflation, we talked a bit about the food inflation being where it is at ten, they foresee that we can start to read report that forecasts are about 5% to 7% for next year. I think it's important on the social point of view to have economic policy that are tailored for people that need them, not the rich. So, you need to have a very tailored, well tailored social policy to help some people by the government. But yeah, you have to make sure that not go too far for a lot of reason because you're destroying the work of the central bank first, and second, if you put the bond market after your tail, I mean, it's not going to be pretty, that's for sure.
Ashleay: And if I go for maybe another topic here, I hear a lot of my friends that are talking about the prices of their houses or even their ability to afford their own house. Is the worst behind us?
Sébastien: Likely not. You know, monetary policy works with a lag. So, when they hike rates or cut rates, it takes a while for the effect to be fully felt in the economy. And economic research has been pretty stable through the decades. It takes between six and eight quarters, so one and one half to two years before the full effect, you know, is felt in the economy. So, the last part being the labour market. So, that's the last piece of the puzzle to react. But housing is up front because the mortgage rates, they have an impact, a direct impact on housing. So, housing prices were up 50% on average in Canada during the pandemic. Now they're falling, which is normal. How far will they fall? How long will they fall for? How far? I don't know. But how long? Likely all the way into 2024. We could see some pressure on the housing sector and maybe more in Canada than in the U.S. even.
Marc: Yeah, no, you're right. The housing market is the first victim of the war against inflation, that's for sure. And also, yeah, Canada, you know, when you want to evaluate the impact of, you know, interest rates on the housing market, you look at the structure of that housing market. And Canada, Canada is a weaker structure, if I can say, on that front, because we have a lot of variable rates loan mortgages in the U.S. In Canada, it's about a third. In the U.S., it's 1%, you know, and in Canada the average term is between 3 to 5 years. In the U.S., you have terms of 15 years, 20 years and even 30 years. So, imagine you’re fixed for 30 years, you know. You look at those interest rates right now and you laugh, you know, you pour another beer and you sit down, and you watch football. That's it. In Canada, you get nervous, you stop consumption.
Sébastien: Yeah, you still watch hockey, but, you know, maybe you drink more.
Marc: Yeah, you drink water, I guess.
Ashleay: So, I'm going to allow myself a question here. I was wondering, why is it that in Canada we don't have like, for example, personally, I tried to get a ten-year fixed loan and everyone's eyebrows went up this high. Why is it that they have such long fixed terms?
Sébastien: Part of that is regulation and another part is, you know, the way the Canadian banking system is structured, it kind of, well, it's structured like that because, you know, the legacy of the system like we have a small number of large banks and they tend to be well behaved. They're not playing cowboys like some banks in the U.S. So, maybe it's a legacy thing, maybe it's a regulation thing. I don't really have the specific answer, but, you know, we are, every country tends to have, you know, their little rules and habits. So, yeah.
Marc: It's more easy in Canada to have a variable rate, for example, and for once, we’re more liberal than the U.S. So, it's a good thing for consumers. If you think that interest rates will go down, go with a variable rate. But if you think that interests will rise, go with fixed rate and then you have more choices in Canada. And some people saw, oh, I, I don't feel like being protected, you know. No, you took your decision. Make sure that you're well, you know, advised before taking that decision because you have more power. But like they say, with more power comes more responsibility.
Sébastien: Yeah. So that quote from Spiderman, right?
Marc: Yeah, exactly.
Ashleay: All right. And so, anyone with investments feels like the last year was particularly tough on their portfolios.
Sébastien: Yeah. And when you look at the markets, you need to understand that it's a movie. It's not like a few snapshots, one after the other. It's a whole movie and things are cyclical. So, we started the year with rock-bottom interest rates, lots of liquidity being injected in the economy. So, everyone was talking cryptos, NFTs and all of this stuff. So, when you have high valuation and low interest rates and then interest rates start to rise, you need to expect the reverse. So, 2020, 2021 were great years for the markets, excluding, of course, the V-shaped bear market that we had in early 2020. But we started the year with high valuation on the stock market. So that had to come down. High valuation on the bond market because interest rates were low. So that had to normalize. But now that we're at the end of 2022, stock market already down 25% at the worst in October and on Wall Street at least interest rates are high. So, looking forward now, we're in pretty good shape.
Marc: Yeah, and I think that in Canada we did better than that because we're a bit less exposed. And when there's inflation, I think that the economic cycle, the fact also that we're more exposed to commodities help Canada. And furthermore, this year we had a kind of a special situation for energy with what happened with the war in Ukraine. Sanctions against Russia, fear of missing natural gas, enough natural gas in Europe. So, Canada did better, especially the energy sector and commodities in general. So, they're not too bad in Canada this year. So, that allowed us to maybe, we're going to end the year close to zero, minus maybe, somewhere I guess between minus two and zero I would guess so. And I think that that's very positive and that's what we'll see for 2023.
Sébastien: Yeah. So, I mean, if you want to recap 2022 in the markets very quickly: rates were at rock bottom, and they had to rise quickly. So, that shook the market. But that puts us in the right position for 2023. Maybe we could, you know, dig into that in an eventual outlook for 2023.
Ashleay: Absolutely. Well, thank you so much to both of you. And I think it's normal that, you know, our listeners may have questions or uncertainties, but we'll be back next year in 2023 to answer all of your investment and economy questions as best we can. And so, from all of us here at the “In Your Interest!” podcast group, have an excellent holiday season and we'll see you in 2023. Love this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast available on all platforms, visit the economic news page on ia.ca, or follow us on social media.
Sébastien Mc Mahon joined iA Financial Group’s economy team in January 2013. Throughout his career, Mr. Mc Mahon has held various positions in several prominent financial institutions, notably at Quebec’s Ministry of Finance and the Autorité des marchés financiers, Quebec’s financial market regulator.
Sébastien Mc Mahon also serves as Vice-President, Asset Allocation, and Portfolio Manager for our subsidiary, iA Investment Management Inc. (iAIM), with assets nearing $15 billion. Mr. Mc Mahon is also a member of the firm’s asset allocation committee.
Sébastien Mc Mahon and Marc Gagnon
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