The worm has turned. Volatility is back on the agenda, rates are rising and investors are realizing the good times don’t last forever.
In other words, according to Rob Edel, chief investment officer at Nicola Wealth Management, we’re back into a normal business cycle featuring market highs and lows with a recession the end game.
He doesn’t believe that’s happening any time soon but there are a number of things in Canada and the US that companies and indexes are now sensitive to.
Here, Edel explores five key areas that advisors and investors should be keeping a closing eye on.
What’s going on in Canada?
What impacts the US will impact Canada, but I think in Canada there are two things that are a little different.
One is from the index perspective, there is a large exposure to commodities, largely oil, and when you look at Western Canada Select Crude, it’s trading significantly lower than US WTI and so that’s obviously going to be impact the market.
The other thing I worry about with Canada is debt levels and housing. One day the housing market will correct - we’re talking about Vancouver and Toronto and I think it extends beyond that. And because Canadian consumers and home owners have a lot of debt, I do think that does put a limit on how much the Bank of Canada can follow the Federal Reserve in increasing rates.
Other than that, what’s good for the US is good for Canada, meaning Canada should benefit from a stronger US economy
Rapid rate rising?
People are saying three for Canada and the Fed is saying one more this year and three next year. Absolutely more volatility – just to get to a normal volatility means more!
When you have this idea of normalizing interest rates and you bring into question that idea of when the market runs into problems, the Fed is there to help … if that’s brought into doubt, now you’re just moving back into what you’d think would be a more business cycle environment that, in theory, is going to end in recession.
From our perspective, we don’t see it as [happening] now and so the correction we saw last month wasn’t so much that. But it was recognizing this idea that you’re going to have periods where fundamentals start to count and if you start to worry that earnings growth is slowing, that can impact the market.
Inflation the key indicator
It will be the guideline for the Fed. I think they want to raise rates, they want to normalize interest rates and they want to have a little dry powder available for them to cut rates when they go into the next recession. How quickly they go there will depend very much on inflation. It is a question of whether we will see more wage inflation and what will tariffs do to inflation? What will oil do to inflation?
They are all things that can go either way but I would say you’ve got to keep your eye on inflation because that will be the real barometer to how close we are getting to the end of the business cycle.
How to combat volatility?
One of our advantages is we have a lot of our client assets in private assets - be it real estate, private debts and equities, and mortgages, so we have the advantage that we don’t have the mark to market risk and I think that helps with investor psychology.
It’s our job to regulate that to look through the noise but it makes our job easier when you don’t have that volatility in price.
Is trade tiff a ticking time bomb?
You thought that maybe the strategy was to get some concessions to get some wins and this wouldn’t be a longer term thing on both sides, that China would throw them a bone and that would help Donald Trump say, look what I did either for the mid-terms or the 2020 presidential election.
It still might be that but I’m not 100% convinced. Also, there is more rhetoric, not just with the administration but with Congress as well. This is a larger issue and it extends beyond trade.
If you think about how supply chains could be altered, yeah it could absolutely add to volatility and be an issue for the markets.
From a political point of view, you’d be willing to accept some lower market returns if it’s strategic. It’s very hard to call, though. If anyone has a read through on what Trump is thinking, good luck!
It’s the one thing that we have become incrementally more bearish on because we are seeing signs that this is bigger than maybe we had thought.
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