Market Watch: January 6

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U.S. stocks fell Thursday, as strong labor-market data reinforced the case for the Fed to keep rates high in the fight against inflation. That was especially bad news for the Nasdaq, which shed roughly 1.5 per cent by Thursday’s close, while the Dow and S&P 500 surrendered a bit over 1 per cent each. In Canada, the TSX also lost ground, dropping 82 points on mining and tech weakness. Looking back on 2022, it was an especially painful year for equities. The S&P 500 dropped 19.4 per cent, while the Nasdaq fell 33 per cent, as growth stocks were continually battered by rising rates. Meanwhile, losses for the Dow and TSX were a bit more modest, at 8.8 per cent and 8.7 per cent, respectively.

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U.S. Indexes Lose Ground; TSX Up Slightly

For the three trading days covered in this report, the Dow lost 217 points to close at 32,930, the S&P 500 dropped 31 points to settle at 3,808, while the tech-heavy Nasdaq sunk 161 points to close at 10,305. In Canada, the TSX gained 122 points to end at 19,507.

Strategy

IMF warns of a challenging year ahead for the global economy

The simultaneous slowdown of major economies raises the risk of a global recession, says IMF – International Monetary Fund (IMF) Managing Director Kristalina Georgieva who said that the global economy faces a “tough year” ahead as a third of all countries could fall into a recession.

Her comments echo remarks made by the IMF in its October World Economic Outlook publication. In that report, the organization also said that there is a 25 per cent chance of global growth falling below the 2 per cent mark, a scenario that it defines as a global recession. Ms. Georgieva added that the cause of the slowdown could be attributed to the world’s three largest economies – the U.S., EU, and China – all slowing down simultaneously.

The European Union continues to feel the ramifications of the war in Ukraine which has upended energy markets and forced authorities to shore up energy supplies to withstand the winter season. Luckily, a warmer-than-expected start to winter has offered some respite. According to Gas Infrastructure Europe, gas inventory levels across the continent are more than 80 per cent full, far above the five-year seasonal norm of 70 per cent.

In China, the country’s efforts to quickly reopen its economy have caused a flare-up in new infections, leading to a slowdown in business activity. Specifically, activity in the country’s services sector fell to its slowest pace since February 2020 as a surge in new cases prompted people to stay home and businesses to shut.

The picture in emerging and developing economies appears even more gloomy, according to the IMF’s head. That said, Ms. Georgieva added that the U.S. economy may be able to offer some reprieve owing to the strength of its labour market. If the U.S. labour market continues to hold firm, it could help to offset a lot of the stress that could be faced globally this year.

Despite last year’s sell-off, equities may have yet to bottom – 2022 was a challenging year for most asset classes with both bonds and equities selling off simultaneously amidst concerns about aggressive central bank tightening and geopolitical tensions. While investors will remain focused on where policy rates peak and how long they stay elevated, we think the conversation this year will shift toward earnings as the lagged effects of last year’s tightening start to filter through the economy. While they have been revised lower, bottom-up earnings forecasts are still calling for growth in 2023 and could be recalibrated further.

Our work shows that corporate profits have historically contracted by ~20 per cent over the last 10 recessions and that markets tend to bottom about 8 months from the onset of a recession. Given that an earnings decline of a similar magnitude could pressure equities further, we continue to advocate for a high-quality bias. High-quality companies typically have less debt, making them less encumbered by rising interest rates, as well as strong balance sheets and competitive advantages. As such, they may be able to withstand economic uncertainty better than their low-quality peers.

On the fixed income side of the ledger, long-duration government bonds sold off alongside equities last year as rising interest rates created a hostile environment for the asset class. While the simultaneous decline in equities and long-dated Treasuries is rare, we expect the latter to bounce back this year as recession fears prompt haven flows into the asset class, driving their prices higher and yields lower.

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