Stock market rally: mirage or reality?

Our Chief Economist's advice and strategies will feel like an oasis in the desert.

Ashleay: Welcome to the “In Your Interest!” podcast from iA Financial Group, where we discuss your need-to-know economic news and how it affects your finances. All this in under 10 minutes. It's always before dawn that night is the darkest. Investors have been experiencing dark times since the beginning of the year. The stock and bonds markets are currently failing. Why are we in this situation? My name is Ashleay. I'm here with my colleague Sébastien Mc Mahon, our Chief Strategist and Senior Economist here at iA Financial Group. Hi, Sébastien.

Sébastien: Hello, Ashleay.

Ashleay: All right, so if we go back, a little retrospect on 2022, can you give us a portrait?

Sébastien: Sure. So, as we are recording this, we're in October 2022 and the stock market is in a bear market. So, that means that it's down more than 20%. Same thing for the bond market. So, it's the first time since 1969. So, it's been 53 years that, if the year ended today—and it's very likely that we'll end there anyway—that we’ll have negative returns for both stocks and bonds in a given year. So, 2022 has been quite a year. So, we always need to look at the starting point because any portfolio manager like myself will tell you that, you know, it's kind of arbitrary to look at things from January 1 to December 31 because there's always, you know, markets are always moving. But, you know, we need to play the game here and the starting point in early 2022 and January 1 was that we had very high valuations for stocks and bonds. That means that we saw stocks as being very expensive on an historical basis and bonds as being also very expensive on an historical basis; for bonds it’s because interest rates were very low. And you know, when interest rates are low, that means that bonds are expensive. And if it's something that interests you, there's some material in the Economy finance 101 section on the web page, so I can refer you there. So, at the beginning of the year, everything was expensive. And when I say everything was expensive, it means that there was a lot of liquidity in the market. So, when interest rates are low, that means that there is lots of money just going around. Everything is expensive, must be. A lot of people are speculating and maybe you recognize yourself or you recognize someone close to you. But you know, we're hearing a lot about cryptocurrencies. We're hearing about NFTs or, you know, people buying drawings of monkeys and rocks for high, at high prices and expecting to make money out of that. So, seeing that as an investment. So, that's a very speculative environment. And us as strategists and as economists, we were looking at inflation coming up and we were saying that, well, central banks will need to hike rates to normalize monetary policy. And when you have a normalization of the monetary policy, it's just like central banks coming in with a big vacuum machine and just, you know, just taking liquidity out of the economy and the markets. So, when you take liquidity away, you tend to have a deflation of valuations of financial assets. So, this is kind of the story of 2022. It’s kind of a perfect storm, that the starting point was very expensive, historically aggressive monetary policy tightening from central banks. And you know, and I'm going over, you know, even the uncertainty around inflation because we discussed that extensively, the war in Ukraine, the impact of commodity prices. So, kind of, you know, everyone will remember 2022.

Ashleay: Absolutely. And we also had droughts that, in addition to the human disasters we had with the war in Ukraine.

Sébastien: Yeah.

Ashleay: So, that caused more food inflation. Correct?

Sébastien: Yeah, exactly. That caused some human pain because, you know, we're seeing already inflation. Probably it has peaked in June 2022. Inflation, total inflation is coming down, but inflation for the price of food, this is still going up. And, you know, Ukraine produced a lot of food, Russia produced a lot, is still producing a lot of food. So, because of all of those sanctions, you know, that means that prices went up and even, you know, fertilizers. We don't think about that, but fertilizers, the price of fertilizers goes up. That mean that the price of food will also go up eventually. So really a perfect storm on all fronts.

Ashleay: I see. And so, if we look at today, you talk about bear markets. Now, are they always the same? What does our market look like now?

Sébastien: Well, markets are never exactly the same, but you can always go to the maybe the DNA. So, the bear markets, there are some similarities that can, you know, at least guide you, play the odds as an investor. So, a few things when you look at bear markets in stocks. So, the stock market is down 20% plus since the high of January 4, 2022. That was the peak dollar, the highest close of the year. So, we're still in the bear market. Bear markets, when we look at all of the bear markets since 1870—so about 150 years of data—we find that the median bear market lasts more than one year. So right now, we're about to end the 10th month of this bear market. So, we're getting close to a year, but we're not there yet. So, it would be a short one versus the median or the average if it was to end today. The other part is that when you look at the drawdown in the bear market, so how low can markets go? The lows that we've seen now came in mid-October, -26%, somewhere like that. But the median bear market over the last 50 years was about -33, -35%, in this vicinity. So, if it ended here, it would be shallower than the median bear market. And the last thing that's interesting and that we spend some time looking at is that, you know, usually bear markets end in a panic event or capitulation and you see, you know, a flushing out of the market, volatility just spiking up. And it might sound peculiar to those listening to us, but asset managers will look at the markets in 2022 and we still feel that the sell-off was somewhat ordered. We didn't see really strong periods of, you know, panic. And typically, you need to see panic before you can call the end of a bear market. And unfortunately, if you put all of those three things together now, we think that we're not there yet and probably the next few months, it's still a good idea to be careful or defensive in your positioning.

Ashleay: I see. And what about the geopolitical developments? I think we have to keep Europe under the microscope.

Sébastien:  Yeah, of course. So, 2023, that's going to be a year for geopolitics. So, monetary policy tightening, that's probably going to continue for a few more months. So, right now what we're seeing is that maybe somewhere in March 2023, central banks could be done with their fight against inflation. But again, that's a moving target and there's still a lot of uncertainty. But, you know, if we had to make our bet today, it would be maybe somewhere there. Global recession is probable. It's not a certainty. It's never a certainty. But you have COVID Zero in China. That's still, you know, a headwind to that economy. You have the European economy. Again, it's peculiar to talk about that, but we're in 2022 heading into 2023. And the big question is, will Europe have enough natural gas to go through the winter? So, will they run out of energy because of, you know, the sanction and counter-sanction game with Russia? That's another topic for another podcast right there. But there's that. There's in the UK we've seen that—and that's the topic of one of our recent podcasts—that fiscal policy can be put in place to counter the effects of monetary policy. And you know, the impact of that, you know, it's the end game is pretty uncertain. So, I mean, maybe I'll give you the conclusion right now. Markets are really afraid of that. They hate uncertainty. So, we could have some of that, could always happen. Will inflation show signs of coming back to its target? And again, the target for inflation in Canada, it's a range. It's between one and three. 2% is just the midpoint. The Bank of Canada is expecting inflation to get below 3% by the end of 2023. We think it's aggressive, but you know, it's possible, but it's a risk. Geopolitics, you know, China, Russia, Iran. So again, it's easy for me to say something like this, but we don't know exactly how things will unfold in 2023. But odds are that, you know, volatility will still be omnipresent next year.

Ashleay: See, thank you so much, Sébastien, and thank you all for joining us.

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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

Chief Strategist and Senior Economist

This podcast should not be copied or reproduced. Opinions expressed in this podcast are based on actual market conditions and may change without prior warning. The aim is in no way to make investment recommendations. The forecasts given in this podcast do not guarantee returns and imply risks, uncertainty and assumptions. Although we are comfortable with these assumptions, there is no guarantee that they will be confirmed.

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2024-02-26 11:38 EST
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