Investment Focus | Issue 16 | Staying Steady Amidst Economic Shifts: US Debt, Canadian Rates, and Recession Outlook

US Debt Default

The US successfully avoided defaulting on its debt this weekend by reaching a new debt ceiling agreement. This development brings relief to the US economy and stock markets, as the potential consequences of a default have been averted. With a temporary resolution in place, concerns regarding a default and its impact on financial stability can be set aside until early 2025, providing a more stable environment for investors and businesses alike. Although this is just one piece of “noise” this year, it’s one we can now ignore.

Canadian Interest Rate Policy

The Canadian economy is currently at a crossroads regarding its interest rates, sparking a lively debate among economists. While the central bank has maintained steady rates for a significant period, the recent surge in economic growth has led some experts to advocate for rate hikes. They argue that the robust performance of the economy, including factors such as strong housing market gains and a resilient labour market, indicates that it can withstand higher interest rates. However, caution is advised as there are concerns about the delicate balance between curbing inflation and avoiding a potential recession later in the year.

Today (June 7th), the Bank of Canada agreed that the economy has not been slowing enough and decided to increase rates by 25 basis points (with the rate now standing at 4.75%). It looks like rates will be staying higher longer than originally anticipated.

Is a recession coming?

The likelihood of a recession in Canada is another topic of discussion among experts. Accountancy firm RSM Canada projects a 60% chance of a recession occurring by the end of 2023, although they believe it would be relatively mild and short-lived. They anticipate that specific sectors, like the labour market, could potentially shield a significant portion of the economy from recessionary effects. Other findings of a Bloomberg survey of Canadian economists are:
• Rate cuts won’t start until the first quarter of 2024
• 80% of the economists say a soft landing is most likely
• 75% of the economists feel inflation will return to 2% in 2024

How does this impact my portfolio?

As we saw last year, interest rate increases negatively affect the fixed income portion of your portfolio as your current bond holdings are worth less when rates rise. Because we had rates rise so quickly in 2022, fixed income was hit hard with the Canadian bond index suffering a return of -11%. We don’t expect the impact to be anywhere as bad as any further increases (if any) will be small. Currently the Canadian bond index is at 2.5% for the year. Yields are also higher now, so returns on fixed income help cushion any short-term price volatility due to rate hikes. Fixed income is likely to be in low to mid single digit positive returns for 2023. When rate cuts begin, fixed income portfolios will see rises in value although likely not as quickly as the hikes took place.

For equities, the markets have been positive year to date. Canadian equities have had a relatively small gain, whereas the US has had a stronger rebound. However, the US rally has been very top heavy and the companies leading the way have been associated with the artificial intelligence (AI) euphoria that has captured the hearts of investors. The S&P 500 Index year-to-date was 8.9% as of the end of May. If you remove the top 10 holding of the Global X Artificial Intelligence & Technology ETF (Nvidia, Meta, Salesforce, Microsoft, Tesla, Alphabet, Apple, Amazon, Oracle, and Adobe) from the S&P 500, its return would be approximately -2.0%.

With an expected recession by the end of 2023, there will likely be an impact on equity markets. If it’s a mild recession, the consensus is that the effects of a soft landing have been “baked in” to the current prices. If it’s a deeper recession, there will likely be a pullback in equity prices.

What should we do?

If you are taking money out of your investments currently or in the next few years, talk to us about incorporating a cash wedge strategy in your portfolio. If you are more than a few years away from withdrawing from your investments, stay the course as usual. The worst thing you can do is try to time the market or make decisions based on emotions. Investing is not a short-term endeavour. There are dozens of reasons every year to be scared of investing. If we acted on all of them, we would never be invested.

The worst thing you can do is assume bad times will continue indefinitely—just like it’s dangerous to assume good times will last forever.

Please feel free to reach out to us if you would like to discuss your investment plan or any worries that you might have. We would be happy to talk with you.

Disclaimer

This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Caldwell Wealth & Estate Advisory to any person to buy or sell any security or adopt any investment approach, and is no indication of trading intent in any fund or account managed by Caldwell Wealth & Estate Advisory. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Caldwell Wealth & Estate Advisory. Past performance does not guarantee future results.

Mutual funds, other securities and securities related financial planning services are offered through Credential Securities, a division of Credential Qtrade Securities Inc. Credential Securities is a registered mark owned by Aviso Wealth Inc. The information contained in this report was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or a solicitation to buy or sell any mutual funds and other securities.