Central banks remain centre stage

The fight against inflation continued in earnest during November, with little sign of inflation easing materially and sustainably.

The developed market central banks that held rate-setting meetings in November increased rates by 350 basis points (bps). For the year, central banks of the G10 countries have raised interest rates by a staggering 2 400 bps.

The US Federal Reserve showed little sign of easing its stance until late in November when Fed Chair Jerome Powell indicated that the central bank would likely moderate the pace of its increases at its December meeting, with 50 bps now more likely than another 75-bp increase.

The Bank of Canada was the first developed market central bank to respond to concerns about the economic slowdown, announcing a 50-bp hike instead of the 75-bp hike expected.

In Europe, ECB Chair Christine Lagarde maintained a hawkish stance, even after a slight easing in the region’s consumer inflation rate to 10% in November from 10,6% the previous month. The Bank of England also remains on red alert, making its eighth interest rate hike in less than a year and taking its benchmark rate to 3%, the highest it has been since November 2008.

China prioritized economic growth by adding liquidity to the world’s second-largest economy. The People’s Bank of China eased its reserve ratio by 25 bps, releasing $75 billion in long-term liquidity to support the economy at what it called a “reasonable” growth rate. China’s zero-covid stance and property woes have weighed on the economy. However, towards the end of November, the government indicated it was rolling back lockdown measures after a wave of protests took place across the country.

Rising interest rates take their toll

The toll higher interest rates are taking on economies globally is beginning to show in tougher consumer credit, credit conditions and housing markets.
Signs of strain in the non-bank lending sector appeared when credit rating agency Fitch downgraded the ratings of two companies and adjusted the outlook to negative for four. The companies are facing tough operating conditions, with interest rates still on the rise and origination volumes declining.

Housing markets have come under pressure this year, but in Canada, latest data showed an easing in the downward slide in home sales. Home resales increased by 1.3% month on month in October to 424,600 units across Canada – the first increase recorded after resales declined almost 40% over the previous seven months. RBC economist Robert Hogue said the data showed that Canada’s housing market might be entering the latter stages of its cyclical downturn.

In the US, housing sales are still on a downward trend, with pending home sales falling 4.5% in October – the fifth consecutive monthly decline. Over the last year, pending home sales are down a hefty 36.7%.

In the US, consumers are getting deeper in debt, with the New York Fed’s Quarterly Report on Household Debt and Credit recording a $351 billion increase in total household debt to $16.51 trillion in the third quarter. Credit card balances increased by 15%, the most significant annual increase in 20 years.

One sign that borrowers are struggling to meet their debt commitments, missing payments and defaulting on loans is Goldman Sachs’ loss rate on credit card loans, which has risen to 2.93% in the second quarter and is higher than sub-prime lenders and worse than other US card issuers.

Another segment of the economy hard hit by the economic headwinds is the IPOs, which have virtually come to a standstill this year in the face of high interest rates and a decline in risk appetite in the face of possible recessionary conditions next year. According to the New York Stock Exchange President Lynn Martin, IPOs have declined 93% this year compared with last year. By mid-November, a mere 173 companies had listed on the US stock market versus 973 over the same period the previous year.

The dollar puts emerging markets under pressure

The dollar has ruled the roost this year in global foreign exchange markets – the dollar index has gained about 9% year to date, even after coming off 5.8% during November. Emerging markets have borne the brunt of the strong dollar, with their currencies depreciating substantially and increasing the cost of imports and their dollar-denominated foreign debt.

Egypt took the extraordinary step of delinking its currency from the dollar after it fell to a record low against the dollar in October. Instead, the government has opted to link the Egyptian pound to a basket of assets, including gold and other non-US currencies.

Japan also stepped in to protect the yen’s value by buying up the yen by intervening in foreign exchange markets. This strategy can be very expensive if the dollar has strong fundamental underlying investor support.

FTX hype and collapse underpins crypto winter

The biggest surprise in financial markets during November was FTX going into bankruptcy and putting a cloud over the rest of the crypto industry at a time when cryptos were extremely volatile. There is likely further contagion in the crypto sphere, given the loss of faith in FTX, which was the poster child of the crypto industry and now looks set to become the rogue of the sector.

Fortunately, the crypto industry’s woes are unlikely to cause significant contagion to the larger financial system and economy. But we are still not sure how far the tentacles may have reached in the financial system through loans and other ties. Individual investors, celebrities and institutional investors, including pension fund managers, have been adversely impacted by their investments and associations with the company.

Shine comes off tech darlings

November also saw the tech companies and their leaders lose their lustre in a sector that has traditionally been buoyed by investor faith in the innovators who created these companies and the promise of stratospheric growth under their leadership.

However, turmoil sweeping across the sector highlighted how quickly these tech superstars could fall out of favour. FTX’s Sam Bankman Fried also revealed how a company can look like the next best thing but is a façade that disguises financial mismanagement and failed corporate governance on a grand scale.

Musk has been in the press for what appears to be all the wrong reasons since acquiring Twitter. He immediately announced a wave of layoffs, a process that has been chaotic and heartless and has resulted in the resignation of key executives in critical parts of the business, namely those responsible for ethics, privacy and moderation and safety. Only time will tell whether his hard-driving style will turn this struggling tech enterprise around.

This is against a backdrop in which some of the major tech stalwarts, Amazon, Microsoft, and Facebook parent Meta Platforms, have also announced massive layoffs in a labour market that has been exceptionally tight since the pandemic. Crunchbase News puts the number of layoffs in the tech sector this year so far at more than 88 000. Google’s Alphabet has also been pushed to reduce costs by TCI, an activist investor. As the economy slows, it seems investors are far less willing to pay up for profitless growth.

Softbank, best known for its failed investment in WeWork, is facing further challenges. The venture capital firm is expected to write down around $100m from its investment in FTX, and Masayoshi Son is said to owe almost $5 billion to the fund because of the tech rout.

The cloud hanging over the tech sector doesn’t mean it should be avoided. As with any other stock market sector, it’s crucial to pay attention to valuations and manage risks for long-term investment success. The tech sector is experiencing mean reversion as growth slows, which could be challenging for investors who overpaid for popular tech stocks.

2022 risks will follow us into 2023

As we head towards 2023, the list of global risks remains long, including the Russia-Ukraine war, which still shows no signs of ending, persistently high inflation and still rising interest rates that are slowing economic growth and creating a cost-of-living crisis. With global fragmentation unfolding as superpowers pursue onshoring, supply chains built long ago may not be suitable for this changing world order. That means structural inflation may remain higher than over the last few decades, and economic inefficiencies may undermine growth.

Amid all the uncertainty and unpredictability, it is essential to distinguish between volatility and the permanent loss of capital. It is the latter that we strive to protect our investors against. We do so by investing in companies with a long history and exceptional performance and by acquiring these companies at reasonable valuations. Our disciplined value investing style avoids speculating on what will be the next big thing.

Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca