Clarity is important in our lives. Unfortunately for investors, clarity is rare in the investment world.
Financial news is full of contradictory statements and contradictory opinions. For example, we have known for over a year that interest rates are going higher because central banks want to decrease inflation. “Everyone” knows that a tight-money strategy causes both inflation and the stock markets to go down.
For the first 5 1/2 months of this year (January to mid-June), interest rates went up and the stock market went down. But for the next five months (mid-June to now), interest rates continue to move higher, but the stock market has zigzagged higher too. Has someone changed the rules?
This simple review of the S&P 500 in 2022 clearly illustrates that there are no rules, only guidelines. And no one tells us when we should use new guidelines. Let’s s review our usual financial markets to see if someone has changed the rules again.
U.S. Stock Market
The S&P 500 rose from the financial crisis low in March 2009 to 2020, when the COVID-19 panic took it down around 20 per cent in about 20 trading days. The U.S. Federal Reserve Board then unleashed its monetary printing press. The S&P 500 jumped from about 2,200 to just over 4,500 in 21 months. This set up “The Bubble” that ended the longest bull market in U.S. history — March 9, 2009 to January 4, 2022. The economic excesses set up by central banks’ too-easy monetary policy had created serious inflation. That inflation is the pin that is popping the bubble of excess speculation in the stock markets and the real estate market in Canada and the U.S.A.
The rules-of-thumb that “everyone knows” are: (1) easy-money policy causes stock markets to rise, (2) tight money causes stock markets to fall, and (3) printing money causes inflation. But, from June to now, assumption (2) did not work: someone changed the rules.
Europeans are experiencing an additional problems — the Russian army, economic sanctions, counter sanctions, shortages and other complications. There is a rule-of-thumb about war. War causes monetary easing and leads to inflation in the warring nations. The U.S. stock market is in a long-term DOWN trend.
Canadian Stock Market
The next rule-of-thumb is that because the Canadian economy benefits from inflation, the Toronto market outperforms New York when inflation is rampant. Because easy-money monetary policy creates inflation, the Toronto Stock Exchange (TSE) should outperform the New York Stock Exchange (NYSE) in times of easy money.
This rule-of-thumb has worked well so far in 2022. The Canadian market top occurred in April; for the U.S., the top was reached in January. The Canadian market declined 19.5 per cent to its early October low, whereas the U.S. market dropped 25.6 per cent to its late September low. Our rule-of-thumb seems to be working. But when we examine the entire bull market from March 9, 2009 to January 4 2022, we easily see that this was a time when markets were dominated by easy money.
Do you remember “Quantitative Easing” I, II, and III? … followed by Jerome Powell’s infamous: we’ll print “as much as it takes” response to the COVID-19 panic — the “easiest” monetary policy in U.S. history. During this entire period, the NYSE outperformed the TSE. It appears our-rule-of thumb didn’t work in the bull market, but is working well in the bear market. Maybe we can invent a new rule-of-thumb to cover that…The Canadian stock market is in a long term DOWN trend.
Notice the following “logic glitch.” The obsolete guideline above is “The TSX Composite has a high percentage of resource stocks that benefit from high inflation.” But, when we do a reality check, we notice that the central banks of the world are trying to drive. inflation down. Doesn’t that imply that they will drive Canadian resource stocks down too? Don’t portfolio managers realize that inflation will be lower next year and the TSX will lose its inflationary lustre?
The Fed and the Bank of Canada will win. High interest rates will drive inflation down. Portfolio managers should be selling their resource stocks now, not buying. (The same advice applies to you.)
Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: i.e. behavioural finance. He is a regular contributor for The Money Letter.
This is an edited version of an article that was originally published for subscribers in the November 2022/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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