Financial Markets Update
March 4, 2023
I am not a financial advisor, nor should you take anything contained in this article as financial advice. It is simply my opinion based on how I am looking at markets. Always consult your own licensed financial advisor before making any financial decisions.
CURRENCIES
There has been marked strength in the USD which suggests a softening of risk appetite for stocks and speculative assets in general. The markets seem to be currently ignoring this dollar strength, but generally a strong dollar means people prefer to have cash on hand rather than other assets. It could suggest a sell-off impending as less sophisticated investors rush to sell based on news that currency traders perhaps already know. A strong dollar also generally foretells weaker commodity prices, but so far we have seen steady strength across a broad commodity basket, likely because of the China reopening post-covid and also because of protracted under-investment in commodity development. This may indicate commodities could rip higher if the dollar should peak and head lower. The relative strength in the US economy also encourages a high dollar as it shows confidence from international investors, and with inflation metrics printing higher, higher bond yields also support a higher dollar. At around 104 on the DXY it doesn’t seem like there are any immediate breakages around the world, however protracted time in the 105-110 range would likely signal some serious problems in weaker international markets.
STOCKS
Nasdaq high flying tech stocks from 2020-2022 have seen a surprising retracement in the first two months of 2023. Is it blind optimism by retail traders? I think so. Everyone was expecting inflation to roll over and allow long duration non-profitable tech to once again regain the lead in markets, however a lot of hot inflation data has made the picture very muddy. Will the Fed raise rates to continue to put the lid on the economy because it’s too hot? Or, has the lag effect in the last year’s rate hikes not had enough time to work and will we see a calamitous drop as simultaneous credit events in corporates and households bite in the end of 2023 regardless of if the Fed hikes or pauses? Or, can the growing economy generate enough buffer to offset higher borrowing costs on everybody, allowing Tech to escape unscathed? The odds seem to be a coin flip at this point with even the Fed signalling they are waiting for conclusive signs themselves. Long story short, with such a dichotomous outcome possible, it is an inherently risky time. I’m staying free of any unprofitable companies until a trend becomes clear. There do however seem to be pockets of very profitable companies paying big dividends today. Mid-cap energy in particular have some incredibly strong balance sheets from last year’s price windfall, and in particular many Canadian energy companies have so much cash and proven reserves that they could privatize fully in 3 years operations. Eric Nuttall of Ninepoint Partners sums up my views perfectly, and although I think his fund is currently overpriced, almost everything in it is worth looking at on pullbacks. There are also some huge-dividend overseas shipping companies that have come off their highs by up to 75% yet are still paying dividends at phenomenal levels. I like these two sectors betting on China reopening, and their recent credit creation.
COMMODITIES
We are seeing incredibly low natural gas prices coming out of unseasonably warm winters around the world. It’s hard to believe only 6 months ago the world was scared to death about the destruction of the NordStream pipeline and giant reductions in supply to all of Europe ahead of winter. Prices went crazy and the immediate crisis was averted (diverted?). I find it hard to believe without the pipelines that Europe will be able to fill the reserves as easily as they did last year. While we may not see the highs of 2022, it seems reasonable to assume costs and volumes can’t be better in practice than they were. As such, I will be picking up natural gas on any large drops. Oil, is a similar story, demand volumes have been steady while reserves in the US have only moderately recovered. Anecdotally, travel seems extremely strong in both aviation and from the hotel industry so I believe going into summer if there is even one factor between travel demand and China reopening, it will easily exhaust any excess supply. Once again, I think Eric Nuttall is right and we have a very high probability of seeing triple digit oil before year end. Long term, if there is even moderate population and economic growth, it also bodes well for investing in producers today at these prices. Within 10 years we aren’t likely to make any reductions in demand, while investment in exploration and production has largely stalled. There is a fantastic asymmetric bet on oil returns in the shorter term. Similarly almost all other commodities have faced under-investment the past decade due to ESG policy and finance constriction. With rates as high as they are now, it is doubly unlikely for these mining companies to be able to get capital in the proportion that would be required if we saw accelerating economic growth worldwide, or any fraction of the actual industry growth of electric vehicles and other green initiatives. All that stuff takes massive copper, lithium, and energy. Heads oil and mining goes higher, tails, oil and mining goes higher. To play devil’s advocate, only a large extended economic slowdown, or some kind of new miracle energy like fusion coming online could derail oil and minerals profits the next decade.
I think gold is a decent hedge at this point too. It might yield slightly higher returns than cash in this environment. If we see any disasters in the Ukraine war it could be a great insurance policy. Other than
FIXED INCOME
It’s a wonderful time for people who need fixed income. In Canada you can get 1 year GICs at 5% with zero risk. In the US you can buy 2 year Treasuries at almost 5% as well. I think younger people who have never seen interest paid to them, nor had to pay out high car or mortgage interest, have no idea of the shift in market. Even though inflation remains high, stocks are arguably in their most precarious valuations in decades if not a century. The P/E of the S&P is still far above its historic average. Continued balance sheet reductions and rate hikes by the Fed all point to worsening environments for stocks and better returns for fixed income. Remember, this is what the Fed wants. They don’t want speculation in stocks or in assets like real estate because it all feeds back to wealth inequality and inflation. “Don’t fight the Fed” suggests it’s time to put at least some money into bonds or other nearly risk-free assets such as GICs. If you look at some of the old-guard guys like Jeff Gundlach or David Rosenberg, they are pounding the drum of bonds.
OUTLIERS
Some of the things I’ve got on my watchlist are:
Sudden escalation of Ukraine war. China supplies arms or makes some overt alliance. Putin gets killed or drops a mini-nuke. This would all cause massive changes in the Fed’s decisions and the sectors of the market that would be interesting.
China actually shows growth. Demographics are starting to work against big Chinese growth, however they know how to plan an economy for growth. If they pull it off, it could be a big tailwind for energy, commodities and any company that does big business with China.
India. India is always the next-big-thing that never quite materializes. Prices of the ETFs have been constantly too high for my liking, however it feels like China is close to peaking and Apple is making serious moves into India. If geopolitics goes awry, India could spring ahead. I would be looking for any pullbacks to make my first investments in Indian ETFs.
CONCLUSION
When even the really smart traders are pulling their hair out about which way the economy and markets could go you should be a little worried. Even the Federal Reserve has thrown it’s hands up in a “I don’t know” gesture. To me, this is a time to wait. Keep cash aside, put a significant portion into fixed income and get paid 5% to wait a year. By then things will be clear, or at least clearly different. As a kicker, I’m looking at select Canadian energy producers with impeccable balance sheets. Given all the tailwinds of high travel demand, ongoing war in Europe and the 2023 natural gas treasure hunt incoming, it seems like the best balance of odds for a successful return into the end of 2023.
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