Market Commentary – Q2 2023

With some exceptions, most markets are higher today than they were at the beginning of the year.  Portfolios have benefited albeit in “fits and starts”.  Defensive positions like infrastructure and consumer staples have shown positive performance however, its a small handful of just 7 technology stocks that has pushed US markets higher, for the most part.

Markets are still watching for signals from central banks around the world in their fight against inflation.  This fight has seen interest rates pushed to a level not seen since 2000.  Inflation is coming down; it’s roughly half of what it was this time last year.  That said, there seems to be no end to central banks “hawkish” language on inflation and their battle to contain it.  Central bankers are using a combination of real action, such as interest rate increases and perceived action, where strong, resolute language on their economic outlooks might move the economy where they want it to go without more intervention.  

The central bank now forecasts the consumer price index (CPI), the measure of inflation, will return to 2.00% (their target) in mid-2025.  I would take this prediction with a grain of salt, given that only 18 months ago, the overnight rate was still 0.25% and there were no predictions from the BoC of where we are today.

With seemingly ubiquitous economic commentary, we can all find ourselves starting to believe that central bankers are all seeing and all knowing “Economic Svengalis”!  

Are they though?  Let’s look back in history to when interest rates were this high, which was in 2001.

As 2000 turned to 2001, the Bank of Canada’s rate was at 6.00%. Today, it’s 5.25%. Back then, GDP was growing by 4.7% and employment was rising by 2.6%. Higher energy prices were boosting exports. There was growth in employment and wages and, together with tax cuts, this grew consumer spending.

To help deal with an overheating economy, the Bank of Canada began raising rates, starting in 1999, and peaking with a 50-basis-point hike in May 2000 to get to 6.00%.

However, all was not rosy. The tech bubble burst in early 2000, and the end-of-year forecasts for 2001 were not great. GDP growth was expected to slip to between two and three per cent, according to private-sector forecasts. Among the concerns were the effects of previous increases in interest rates, higher energy prices and overall weakening confidence.

As it turned out, Canada’s GDP dropped all the way to 1.79% in 2001 from 5.18% in 2000. Unemployment was at 6.83% in 2000 (much higher than today’s rates) but went up to 7.22% in 2001 and 7.66% in 2002.

The Bank of Canada kept its rate at 6% throughout the second half of 2000, but as things weakened in the economy, it felt it was time to cut. Policymakers cut the rate by 25 bps in January 2001, and by the time they were done cutting one year later, the rate was 2.25%, a full 375-basis-point cut in one year.

Did the Bank of Canada predict these moves in May 2000? No, it did not. At the time, it was clearly worried about higher inflation.

There was a clear slowdown ahead in the economy, but things got much worse when the completely unpredictable 9/11 attacks in the United States took place. That helped push a meaningful slowdown in 2001 to a much worse place.

The monthly all-in CPI was just 0.66% in January 1999. As the economy improved, the CPI rose to 2.63% by December 1999, and was at 3.2% in December 2000. By this time, the Bank of Canada had raised its rate to 6.00% in an effort to calm inflation.

The economic impact of the interest rate increases, as well as geo-political events was dramatic. The CPI was down to 0.62% by November 2001.  The central bank was in catch-up mode to try to spur the economy, so it quickly lowered the rate, eventually stopping declines in January 2002, when it was down to 2.25%. The key takeaway for me is that things can change quickly.  

Eighteen months ago, we had super low interest rates in Canada. Today, not so much. In late 2000, the rate was 6.00%. By January 2002, it was 2.25%.

Over the past 30 years, the Bank of Canada has raised rates ranging from 1.25 to 3.2 percentage points on six different occasions (prior to the significant current rate hikes). The one thing they all had in common was that it didn’t take long for each of them to be followed by a period of declining interest rates, ranging from 1.25 to 5.125 percentage points.

Generally speaking, fixed income investments such as bonds, as well as real estate do well as interest rates are falling.  Stocks tend to perform better when interest rates are low.  This should give us all a level of comfort as to where things are headed, going forward.

Regards,

Cory Hill, CFP CIM
Financial Advisor & Associate Portfolio Manager

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