Juggling Dynamite

In June 1999, the US Fed began an 11-month rate hiking cycle that took the overnight rate from 4.75 to 6.5% by May 2000. Amid tech-mania-inspired irrational exuberance, the S&P 500 hit 1527 by March 2000, sold off into the summer, and rebounded to double top at 1521 by September on soft-landing forecasts.

What unfolded was, in fact, a mild 8-month US recession from March through November 2001, with the unemployment rate rising to June 2003. The stock market did not bottom until September 2002, when the S&P reached 688–54% below its March 2000 top.

Canada did not experience an official recession in the 2000-02 cycle, yet the TSX Composite followed US markets in lockstep, falling 52% from August 2000 to October 2002. The stock market would not reclaim its 2000 cycle top for five full years in September 2005. The tech-heavy Nasdaq, which fell 78% between 2000 and 2002, would not reclaim its cycle peak until 16 years later, in July 2016.

After leaving the overnight rate at a debt-stimulating 1% from June 2003 through June 2004, the US Fed finally began a two-year tightening cycle that took the overnight rate to 5.25% by June 2006. With the usual delay between interest rate changes and the real economy, home prices in the US and other countries entered an epic bubble that began to burst in 2006. Still, stock prices rallied on. The S&P 500 hit 1553 in July 2007, sold off into the summer and then double-topped around 1565 that October on soft-landing confidence. The US economy entered the ‘Great Recession’ from December 2007 through June 2009, with the unemployment rate rising to January 2010.

This time, Canada experienced its recession from October 2008 through May 2009, with its unemployment rate rising until the fall of 2009. Coming into the 2008 recession with less debt and less inflated home prices, Canada’s economy fared better and recovered faster than many other countries. Still, Canada’s stock market followed the US decline in lockstep, with the TSX Composite peaking in October 2007, double-topping into May 2008 and tumbling 47% into March 2009. The TSX did not durably surpass its May 2008 cycle top until December 2020–more than 12 years later.

In November 2007, as soft-landing advocates were loud and stocks still rich, I wrote a blog article, Looking Up From the Minutiae to See the Big Picture. It turned out that the takeaways were prescient then and bear repeating now.

And so we see that a person who held Government of Canada bonds and T-bills throughout the past 8 years would actually have fared better than the vast majority of investors.

Those who avoided passive allocation strategies in equities over the past 8 years actually did not miss the boat. They caught the lifejacket. They missed out on the agony, angst and upset of large market losses and emotional trauma.

The long always industry is still selling everyone this passive, buy and hold bill of goods. And most investors, sadly, will continue to suffer the consequences unless, of course, they WAKE UP and see that there is a better way.

As in 2000 and 2007, at current levels, stocks are priced to underperform the safest bonds over the next several years. History never repeats exactly, but financial cycle behaviour is remarkably consistent. We can use that knowledge with discipline to our benefit.

Rebounding Treasury bond prices have lowered mortgage rates from their cycle high in October, but home prices at current mortgage rates are still painfully unaffordable for most.

The Bank of Canada estimates that 45% of Canadian homeowners saw their mortgage payments rise in 2023, and 50% of mortgages initiated before March 2022 will face higher rates by the end of this year. The average payment increase is expected to be 34% and 54% for the most indebted households.

At the same time, home sale volumes have fallen from a national peak of 76,259 in March 2021 to 35,013 in November and an average price of $816,720 in February 2022 to $646,134 in November, a decline of 21% (WOWA chart below).

Would-be-sellers are being advised to hold off until the spring, hoping that lower interest rates will yield more buyers by then. Not everyone can wait and hope, though. Listings are rising, especially in areas where homes are the least affordable. See Hoping for early spring in a chilly housing market.

In November data, new listings in the Greater Toronto Area (GTA) were up 19% year-over-year to 10,545, while active listings soared 41% to 16,759 and far outpaced the 7% decrease in GTA home sales over the past year, down to 4,236.

The average home sold price in the GTA was $1,082,179 for November 2023, representing a decrease of 4% month-over-month and more than 17% lower than the cycle peak in early 2022. GTA home sales accounted for 12% of all Canadian home sales. The GTA had a sales-to-new listing ratio (SNLR) of 40% in November, up from 37% in October. An SNLR under 40 is considered a buyers market. John Lusink, president of Right at Home Realty and Property.ca, says the market is stuck. Buyers point to low sales volumes for negotiating a reduced price, while sellers point to flat year-over-year prices as a reason to hold firm.

Trends are not seller-friendly. Mr. Lusink says the inventory of listings on his site was 40% higher in December compared with the same month last year and 100% higher compared with December 2021. For more, see: Toronto just saw the worst year for home sales in 23 years.

Assets bid up by irrational amounts eventually end up on clearance sale. Always. This is something to remember with the seven most expensive tech companies ending 2023 at their October 2021 price peaks (chart shown below, courtesy of All Star Charts), even while the Fed funds rate has moved from .25 to 5.5% and earnings estimates are falling. Sure, this handful of stock all-stars have spent two years going nowhere with tons of volatility, but who cares?

Permabulls are emboldened. The CNN Fear and Greed sentiment index is back in the extreme greed zone. Lessons learned: zero.

Making up a record 31% of the S&P 500 and 45% of the Nasdaq market capitalizations, the ten most expensive tech companies attracted trend-following flows into the bloated S&P 500–a CAPE above 30x in December–by the highest dollar amount on record (chart below since 1999, courtesy of The Daily Shot).

Rebounds in the few have masked ongoing price weakness in the majority.

Even though many companies borrowed long when interest rates were at 5000-year lows during 2020-21, the level of debt matters and forty percent of Russell 2000 companies had negative earnings in 2023–alarmingly high in a non-recession year. The negative earnings share was half that amount heading into the 2001 and 2008 recessions, and then it doubled (see grey bars below since 1995, courtesy of Game of Trades). Credit spreads on publicly-traded ‘hi-yield’ debt started 2024 at a complacent 321 basis points over similar-dated Treasury bonds–much too low for the capital risk inherent. Past bear markets have not bottomed until high-yield spreads have widened to more than 7oo basis points, with junk bond prices dropping with equities.

Large-cap companies are typically more financially stable but still saw a tripling of the negative earnings share during past recessions. The S&P 500 money-losing share at 5% today (in green below) is due to move up from cycle lows. After spiking on hopes for rate cut miracles in 2024, the S&P 600 small-cap stock index (in green below since mid-2021, courtesy of my partner Cory Venable) ended 2023 still -9% from the October 2021 top. Late cycle tech out-performance in the 2008 top (circled in the inset box below) resolved with the S&P 500 following small-cap stocks into a halving. Often, January clocks stock market gains following tax-loss selling in December. But after manic buying last month, this year might be different. Yesterday’s -1.6% was the worst annual start for the tech-centric Nasdaq since 2016, and economically sensitive small caps, transports, and commodities all followed lower.