Over the summer, the U.S. reported its second successive quarter of declining GDP, which commonly defines a recession. Yet, the U.S. government pointed to economic data that suggested otherwise: strong jobs growth, robust corporate earnings and continued consumer spending. However, it prompted considerable debate about whether the U.S. had entered a recession, and if Canada would follow. Semantics aside, there is little doubt that we have entered a slowing economic period, largely due to continuing efforts by the central banks to aggressively raise rates to curb inflation.
How Do Rising Rates Affect Economies and the Markets?
Higher rates raise the cost of borrowing, which can lead consumers to spend less. While decreased demand for goods and services eases inflation, it can also impact a business’ profitability. Rising rates also increase the cost for companies to borrow money, along with the cost of holding debt. Sometimes companies pass these costs along to consumers. However, if they cannot, it can potentially impact earnings and lower stock prices. As well, valuations often go down because the future value of cashflows is lower when a higher discount rate is used. With fixed income markets, as interest rates rise, bond prices generally fall. This is why we have seen both stock and bond markets struggle in 2022 as the central banks raised rates.
Is a “Soft Landing” Still Possible?
Renowned economist John Kenneth Galbraith once said, “The only function of economic forecasting is to make astrology look respectable.” Although likely said in jest, the point is to suggest that nobody knows with certainty how economies will perform over the near term. Economic slowdowns will occur from time to time and recessions, when they do occur, can be quite different in their length and intensity. At the time of writing, labour markets continue to be relatively strong, with low unemployment and job vacancies. While unemployment is expected to rise as the economy slows, higher savings rates among many Canadian households may act as a buffer. Productivity has also been stable, and our economy has benefitted by being a net exporter of resources. As such, some believe that Canada may avoid a full-blown recession.
What About My Portfolio?
The potential for a recession should never be a reason to consider curtailing investment programs. Portfolios have been positioned to weatherthe inevitable down periods, with a focus on quality investments, which can be expected to regain their values when better times arrive, as well as diversification and asset allocation to help reduce portfolio risk.
Consider also that the stock market and the economy don’t always move the same way at the same time. History has shown that markets can begin their upward climb when economic conditions are at their worst. A look back at the last seven U.S. recessions reminds us that the S&P 500 Index has, as often as not, started its climb during the depths of a recession (chart).
A Pullback, Then More Growth
History also reminds us that periods of retrenchment have always been followed by new growth, economic expansion and improved equity values. There is little reason to expect otherwise in this cycle. Moreover, even during the most challenging times, things can quickly change, so continue to look forward. As always, we remain here to provide support.