Market Musings

Good day to you all.

Already the start of February. On Friday the second, Punxsutawney Phil the groundhog will emerge from his lair, check to see his shadow, and if he does, he will retreat into his lair, and we will have another six weeks of winter. Should he not retreat (or see his shadow), we will have an early spring...

Statistically, the groundhog has been correct in its prediction 39 per cent of the time (since the 1880s). Are we making a parallel? Perhaps. Over the last month, the mood (economically) has shifted a few times. Early January had expectations of early rate cuts by the U.S. (and others) federal reserve. Since then, the economy has showed signs of strength. The most recent U.S. GDP read is an annualized 3.3 per cent. Consensus had been 2 per cent. So, while inflation slowly ticks down, growth is also present. Therefore, the fed does not need to raise rates (as inflation is slowing), but the economy is being resilient, and no rate cuts are needed to prop up the economy.

Attitudes have changed and will continue to do so. Will the economy see its shadow and retreat? Or are we in for an early spring? Stay tuned.

The situation in Canada is perhaps slightly different in that the economy is not accelerating as much, but inflation is still present. The Canadian central bank has its challenges ahead, due in part to the residential real estate market, as we wrote about last month.

We have been telling many of you about the benefits of discount bonds, and the premium after tax yield that we can get. Let’s dig into this a bit further.

Bonds that were issued several years ago when rates were much lower have very low coupon rates. These bonds now trade at a discount. Why? Because those older bonds offer less return in the current market.

An example: The government of Canada issued a bond years ago that matures on Sept 1, 2025. The interest rate stated on the bond was set at 0.5 per cent (on half of 1 per cent). Current rates for a bond that matures on Sept 1, 2025 are at about 4.1 per cent. For the first Canada bond mentioned to be competitive, it needs to be bought at a discount. Therefore, the market is pricing that Canada bond at 94.50 (in lieu of 100 at issue price). So, anyone buying the bond will get 0.5 per cent interest (as per the coupon) and also receive an additional 5.5 at maturity (the difference between the 94.50 per cent purchase price today, and the maturity value at 100 per cent.

The important part here is that the difference between the cost and the maturity price is not considered interest, it is considered capital gain which is far more beneficial from a tax perspective. The maximum tax rates for interest and capital gain are roughly 50 per cent and 25 per cent respectfully.

A quick comment following a few comments we received since we last wrote. We are regularly recommendingmanaging for the long term. This is because we understand that you need to be exposed to the market for long periods of time to realize the full potential. This is also why we are never “all in” or “all out”. The S&P 500 in 2023 is a great example of this. Most of the 26.44 per cent (including dividends) occurred in between mid-October and December 31 (about 16 per cent). Keeping a foot in the water, and a foot onshore is a reasonable approach.

Getting back to some old habits:

We took a look at the CNN fear and greed index. It is clearly in the extreme greed zone. What this means? The market may be overbought, and either scheduled for a pause, or a…?

The wages and salary growth in the U.S. indicates expansion and are inflationary. From a low of 5.185 per cent (and an increase Q over Q). Last quarters read is +6.769 per cent. This is still inflationary.

The Chicago PMI came out on Wednesday morning. Consensus expectation was set at 48.1, while the actual read came in at 46.0. The prior read was 47.2. Not only was it a miss, but it also shows weakening month over month. This Business Barometer provides an overall gauge of business activity as published in the NAPM – Chicago monthly Business Report. An index reading above 50 per cent indicates that economic activity is generally expanding; below 50 per cent, that it is generally declining.

Conversely, and in the same breath though, the Markit Manufacturing PMI is above 50, and surpassed the consensus target in its last read.

The ADP National Employment Report is a measure of employment based on an anonymous subset of ADP payroll data covering approximately 225,000 establishments and 14 million employees working in all 19 of the major North American Industry Classification (NAICS) private industrial sectors. The data is collected for pay periods that include the week of the twelth of each month and processed with statistical methodologies like those used by the U.S. Bureau of Labor Statistics to compute employment from its monthly survey of establishments. While consensus expectation was for a 145, the actual read came in at 107, and the prior read was 158 (all of these measure in thousands of employees).

Today, the U.S. Federal reserve maintained the overnight lending rate. Chairman Powell indicated that there would likely not be a rate cut in March. As Jeffrey Gundlach (https://www.forbes.com/profile/jeffrey-gundlach/?sh=77b4a1605784) suggested, don’t expect any rate cuts untilmaybe May (baseline in June).

There are a significant number of important economic measures. The direction that they suggest are all mixed. Our point being, it’s a confusing time, and as such, a dose of caution is appropriate in our minds.

Wishing you all a great February, and as always, we look forward to your questions and comments.

Erik and Guillaume

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