A chill in the air

By: Adam Ditkofsky, Pablo Martinez, Sandor Polgar, Steven Lampert, Craig Jerusalim and Rahul Bhambhani

Economic data

We can all feel it; the sun still shines brightly in the sky, but its strength is waning as it sets earlier every day. Trees proudly wear their foliage even though patches of red, yellow and brown start to emerge. Summer tries to cling but Canadians know better and start preparing for the cold season. Even markets seem to be bracing for rough weather. The economy has been resilient so far, but the signs are out there: inflation remains elevated and consumers come to the realization that the season of ultra-low interest rates is behind us. We can see it in the Conference Board consumer confidence index which came out lower than anticipated at 103 versus 105.5. While the present-situation number was close to unchanged, expectations for the next year took a severe hit, dropping close to 10 points to 73.7. As confidence dwindles, so is the appetite for housing; new home sales dropped 8.7% in August and pending home sales saw a decline of 7.1%; mortgage rates north of 7.5% are enough to cool most buyers’ enthusiasm. The final revision for Q2 GDP came out in line with expectations at a healthy 2.1%. The surprise came from the personal consumption number, which was cut by more than half to 0.8%, a sign that higher interest rates are hurting consumer spending power. The price index came out lower than expected at 1.7%, but yet again, the core number remains elevated at 3.7%. Personal income and spending were in line with expectations, both at 0.4%, but here again, the inflation measure (core personal consumption expenditures deflator) is still above the Federal Reserve target at 3.9% on a yearly basis. 

This side of the border, Canada’s job market seems to be cooling off as the survey of payroll for July showed that a mere 4,900 jobs were created and that vacancies declined by 43,000. The bad news for the Bank of Canada was that weekly earnings increased 0.8% on the month, taking the year-over-year print to 4.3%. The risk of a wage spiral fueling the inflation cycle remains very much alive and may force the central bank into keeping rates at those high levels for longer. Adding to the mix a flat reading to GDP for the month of July, we are starting to see the ingredients for a meal nobody wants on their menu: stagflation. 

Bond market reaction

Summer is definitely over for the bond market as yields continued their march higher this week. The 10-year Canada bond powered through 4% and the 5-year finished the week at 4.25%, more than 40 basis points higher in a single month. Definitely bad news for those looking to buy a home or renew their mortgage. Markets realize that most central banks are at the end of their tightening cycles but higher rates are probably here to stay. The yield curve steepened as investors want to be compensated for buying longer-term debt from governments that are running larger deficits. With such a volatile market, corporate issuance was subdued. New issues were less numerous than previous weeks, but were still well received. Spreads on corporate bonds ended the week stable on low volume. We still find short corporate bonds attractive, but they are becoming harder to find. 

Stock market reaction

Global equity markets were down modestly this week, bringing September to a weak end. Anxiety over ever-rising interest rates continues to weigh on investors’ minds, and discussions over a weakening macro environment are back. A topic of discussion over the last few weeks that’s weighed on medical devices is the success of a “new” class of drugs treating diabetes and obesity, GLP-1s. While GLP-1 treatments have been around for years, newer iterations have shown higher efficacy and weight loss outcomes. Investors in many instances are nervous at the second-derivative consequences these drugs pose for surgical and procedural outcomes – think cardiovascular and renal complications. The next few years will be interesting with a ramp-up in supply and distribution at Novo Nordisk, and new product launches at Eli Lilly. On an unrelated note, Nike reported quarterly results showing a 10% decline in inventory levels, a positive indication after several quarters of inventory build-up. Nike struggled over the past year with discounting and moving older stock, which seems to be getting under control. Every cycle has its ups and downs! 

What to watch next week

Investors will need to keep their cool next week as important employment data will hit the market. We will get both the US non-farm payroll number and Canada’s net change in employment. Those reports will also show if wages start reverting to a trajectory more in line with a 2% inflation target. We will also get an assessment of the state of the manufacturing and services sectors in the US with the Institute for Supply Management’s reports.

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; Pablo Martinez is Portfolio Manager, Global Fixed Income; Sandor Polgar, Portfolio Manager, Global Fixed Income; Steven Lampert is Associate Portfolio Manager, Global Fixed Income; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

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