Juggling Dynamite

This week, the Swedish central bank followed Switzerland in becoming the second G10 nation to ease base rates in the banking system. Both cited weakening economic activity.

The Bank of Canada is expected to follow suit this summer, with 45% of outstanding Canadian mortgages up for renewal this year and next. Most were taken out when interest rates were an abnormally low sub 3% (2020-21). Now, debt service costs are leaping while unemployment is on the rise. This is negative for consumption-driven economies where GDP growth depends heavily on ever-higher spending on goods and services.

Once they start, central bank easing efforts tend to be contagious, and it’s quite likely that the Bank of Canada will end up easing faster than is presently priced into asset markets. However, monetary easing is no quick fix and typically takes several quarters to filter through the economy. Royce Mendes follows the Canadian data closely.

Royce Mendes, managing director and head of macro strategy at Desjardins, joins BNN Bloomberg to discuss the health of the Canadian consumer as retailers post cautious outlooks. Mendes says higher interest rates do a lot more to slow down spending in Canada than in other countries. Mendes also discusses the housing market and his top economic concerns. Here is a direct video link.

Danielle DB does a good job of summarizing the latest data, suggesting that a US recession is nigh and corporate revenues and employment are set for a drubbing.

From the NYSE site, Caroline Woods and Danielle DiMartino Booth discuss the Fed’s continued fight against inflation, the spending power of U.S. Consumers and how A.I. could impact the labor market. Here is a direct video link.

Canada is further into this downturn than America. Already, in the first quarter of 2024, Canadian business insolvencies climbed 87.2% higher than the same quarter last year:

A weak consumer combined with a soaring cost of doing business has led to a surge in businesses seeking protection from creditors. Experts warn the issue is likely much worse, since the vast majority of businesses that shutter don’t make an insolvency filing, they simply close their business.

As I wrote last October in Resisting financial sentinels, financial-tainment is dominated and sponsored by sell-side firms that urge us to buy risky assets–that’s their business model:

Most of the investment industry sees client accounts as product distribution channels. To hit revenue targets, they pump and dump the highest-risk securities onto their customers.

Even where clients pay a fee for asset management, most firms reserve the right to collect additional, often hidden compensation from product creators. If clients own the least-risk securities like government bonds and cash equivalents, investment fees are relatively little, so, unsurprisingly, these assets are rarely recommended.

But make no mistake: It is typical for dividend-paying equities to drop sharply in recessionary bear markets while central banks are easing financial conditions. “Defensive” for whom, you should ask.

The table below (courtesy of A. Gary Shilling) shows the peak-to-trough price decline for all equity sectors during past recessions (1990, 2000-02, 2007-09 and 2020), as well as the average loss over all four (5th column). Mind those defensives!

The Nanos Pocketbook Index, a component of the broader Bloomberg Nanos Canadian Confidence Index and a measure of how Canadians perceive their personal finances and job security, fell to 50 last week, the same level as the pandemic low in April 2020.

Fifty percent of respondents said that their finances had worsened in the past year compared with just 11% who said their finances had improved. This was the most negative spread in sentiment since the inception of the survey in 2008 (chart below). See: Canadians feel poorer in warning sign for the economy, Trudeau.

Youth unemployment (at 10.9% in March vs. 6.6% in December 2022) has risen about four times faster than unemployment for all age groups. Overall, the 1.1% increase in total unemployment, to 6.1% from 5.0% at the end of 2022, is above 2019 levels and the greatest increase among peer nations. See National Bank: How does Canada stack up globally? Not great.

Dour sentiment and deteriorating employment are contagious, especially in consumption-driven economies. Canada has so far avoided a confirmed recession thanks to lagged data and record immigration, but on a per-capita basis, the economy has shrunk by three percent since September 2022, is weaker than before the pandemic, and sporting the worst growth trend of developed economies (2023-2024 shown below, courtesy of National Bank).On the goods news front, Canadian core inflation (ex-food and energy at +2% year-over-year in March) was lower than most countries. This means that Canada has higher real rates than its peers (shown in red on the lower right) and opens more room for the Bank of Canada to ease financial conditions. Presently, just 60 basis points of 2024 cuts are priced into Canadian bond prices (versus 130 bps at the start of 2024; see bars on the lower left). With no quick economic boosts on the horizon, Canadian bond yields are retreating (bond prices rising) and are now back to where they were last November when Canada’s stock market (TSX) was some 15% below its current level. Disconnects like this are typically short-lived, usually with stocks capitulating to the bond market’s math-based assessments.

All of this reminds us of similar conditions that we described in October 2008 as follows:

As we have said before, for the past couple of years, stock markets have been wildly over-priced and blindly optimistic about economic prospects in 2008 and 2009. The real estate markets have been correcting for a couple of years already, the credit markets have been in severe contraction for over a year. The stock markets of the world have been slow to get it and are now rather violently having to concede reality. Stock investors have been slow to wake up. There is an old saying in finance that the bond markets are driven by the brains, while the stock market is driven by hair brains. The adage is seemingly accurate this time again.

Like now, GDP growth rate estimates were positive across the board in the first half of 2008. It was not until early 2009 that backward-looking revisions began to reveal that the great recession had begun in December 2007. Negative 2008 GDP revisions continued for the next ten years to 2018.

The stock market did not bottom until March 2009, some 50% below the prior cycle peak. It then took six years of government support, near-zero interest rates, and central bank cash infusions for the stock market to recover its 2007 high. By then, many who had bought and held near the cycle top had long since liquidated in losses–a typical outcome.