Making sense of the markets this week: December 11, 2022

The Bank of Canada hikes the rate by 0.50% 

This week, the big event was the rate hike announcement on Wednesday from the Bank of Canada (BoC). As many expected, it increased rates another 50 basis points (bps) or 0.50%. That was my prediction on Twitter: 

I think they need to go 50 bps if they’re serious. They need to crush housing in Canada.

— CutTheCrapInvesting (@67Dodge) December 7, 2022

What does that rate hike mean for your finances? 

Here’s the rate-hike history for 2022. The rate is now at its highest level since 2008. 

1. 1.0%: up 50 bps on April 13 
2. 1.5%: up 50 bps on June 1
3. 2.5%: up 100 bps on July 13
4. 3.25%: up 75 bps on September 7
5. 3.75%: up 50 bps on October 26
6. 4.25%: up 50 bps on December 7

This is from the BoC statement:

“Looking ahead, the Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target.” 

There is a hint of dovishness in that comment. Previous comments suggested further rate hikes were almost certainly on the way. The door has been opened to the possibility that we might have a rate hike hiatus, a hope that was driving markets higher in October and November. 

After the rate hike announcement, I was glued to BNN Bloomberg and Twitter, weighing the expert opinions that poured in. There is a mild consensus that we might now get that rate hike pause, or that the pause will arrive after one more 25 bps hike in late January 2023. 

On BNN Bloomberg, Earl Davis, the head of fixed income and money markets at BMO, predicted a terminal 6% rate, following a rate pause. That’s on the high end of predictions. The consensus is in the area of 5% for a terminal rate in Canada. For the week of November 27, when the U.S. Federal Reserve was “attempting to crush investor hopes,” we discussed what a terminal rate is. I noted that the Fed offered to slow the pace of rate hikes. South of the border, there will be a rate hike announcement next week. 

As reported in the “Making sense of the markets” column last week: 

“The Canadian economy grew more than expected in the third quarter, although the weakening housing investment and consumer spending suggests that higher interest rates are beginning to bite. Gross domestic product (GDP) increased 2.9% on an annualized basis from July to September, Statistics Canada reported Tuesday.” 

For my money, it was that stronger-than-expected third quarter gross domestic product (GDP) reading that put the nail in the coffin of any hopes of a 25 bps hike on Wednesday. The Canadian economy—and the real estate market—is proving to be more resilient than many would’ve guessed. 

Also, the labour market is not buckling. Of course, we need the economy to cool to help in the fight against inflation. 

But, cracks are showing in the real estate market, and this week’s hike will now cause considerable stress for many recent home purchasers who were stress tested back in 2021. 

How Bad Are Variable Mortgage Rate Increases: They Just Blew Past The Stress Test

If you got a Variable Rate Mortgage in 2021 the Stress Test was 5.25% your real rate was 1.45%

Seemed impossible to hit 5.25%

After today’s Increase the a good Variable Rate is 5.45%

No Bueno

— Ron Butler (@ronmortgageguy) December 7, 2022

What real estate expert and brokerage owner Ron Butler is suggesting in the above tweet is that home buyers were tested to ensure they could handle a rate that moves to 5.25%. Many recent buyers moved past that financial comfort level. BoC research shows that around half of all variable-rate mortgages with fixed monthly payments have already hit trigger rates, which frequently means the borrowers need to increase their monthly payments. Many more will now hit their trigger rate thanks to Wednesday’s move. 

Bank of Canada Rate Increase Creates Wider Cracks in Mortgage World: RE Price Effects

Apart from the obvious fact variable mortgage borrowers pay more and that’s worrisome, there are very specific situations that get far worse

1) Alternative Lender Mortgage Renewals

2/

— Ron Butler (@ronmortgageguy) December 9, 2022

It’s getting scary in the real estate space. I follow a diverse group of real estate experts on Twitter and there are so many reports of recent homebuyers getting letters and calls from their banks as they hit their trigger rate. (This is Ratehub’s explainer on the trigger rate. Ratehub.ca and MoneySense.ca are both owned by Ratehub Inc.) 

Folks who bought preconstruction homes and condos may not qualify for a mortgage when it comes time to take ownership. 

The bad news is Canadians are rate sensitive. The good news is we are rate sensitive, and the rate hikes should eventually do the job. 

When? Only the future knows. 

The BoC is already forecasting near-zero growth over the next three quarters, putting the Canadian economy right on the edge of a recession. 

Good news—and bad news—drive U.S. stocks lower

In recent weeks, good news (favourable economic readings) has been bad news for investors. But this week, even bad news started to be bad news for stock markets. Strong U.S. data can rattle the markets, as that means the Fed has to step up the inflation fight. Now markets are awakening to the reality or potential that rising rates might be all too successful in bringing down the consumer, with the economy in tow. 

Here’s the iShares Core S&P 500 ETF over the last week. 

I was watching CNBC when it paraded CEO after CEO, who all echoed the same sentiment and even had the audacity to whisper the R word: Recession. 

The current economic cycle is unusual, according to Liz Ann Sonders, chief investment strategist at Charles Schwab: 

“This is not a typical cycle.”

Recessions typically lead to a peak point when it becomes clear whether or not a hard or soft landing is in the cards. Sonders points to a potential of rolling recessions. She said this moment in the economy feels more like a slow burn. 

“I just think this is not a typical cycle,” she said on CNBC’s Closing Bell: Overtime. In a typical recession, “everything sort of falls all at once, or lands softly all at once. This is happening over an extending period of time, with a rolling nature to it.”

Inverted yield curves have a good record of predicting recessions. We currently have inverted yield curves in Canada and the United States. A recession, of some sort, is likely. That said, past performance does not guarantee future returns. There is no guarantee that we’ll get a recession or rolling recessions. 

And we can add in Dale’s Christmas tree indicator. Yes, it is a real economic indicator 🙂 

Christmas Tree Indicator (yes, that’s real). Not good for 2022. My XMAS tree guy said he’s down 100 trees from last year. Same for others he says. @MPelletierCIO @EconguyRosie @ronmortgageguy @doughoyes @JohnFMauldin @JonChevreau @RE_MarketWatch

— CutTheCrapInvesting (@67Dodge) December 2, 2022

The crude reality 

What’s going on with oil prices? They’re falling, responding to recession fears and the China COVID lockdowns. Those restrictions will suppress economic activity. The oil selloff comes after the West hit Russia with new restrictions that, so far, at least, do not appear to be derailing global energy markets. 

U.S. oil fell 3.5% to USD$74.25 a barrel on Tuesday—the lowest settlement since December 23, 2021. Oil continued to slide late into the week. That leaves oil down by 45% since briefly topping USD$130a barrel in March amid fears about Russia’s invasion of Ukraine. 

Despite the drop in energy prices, OPEC is staying with its game plan. On Sunday, the oil cartel announced plans to stick to its oil production cuts rather than taking steps to take more supply offline. OPEC is looking to keep oil in the very profitable USD$80 to USD$90 range. 

The sharp drop in oil prices is mostly good news for consumers and the fight against inflation. The price at the pump should continue its recent plunge. We see the same level of price declines in Canada. 

What’s interesting is that oil stocks are not following the price of oil. Oil stocks have been the best performing sub-sector in 2022. The decline has been modest. Here’s the Canadian index over the last year:

Over the long term, most projections call for oil at USD$100 and above. Investors in oil and gas stocks are hanging in there. Count me in on that front. We don’t need USD$100 oil to be successful. My oil expert sources suggest dividend increases may disappear when we approach a USD$50 oil price. 

Bonds are back as a sensible investment 

“Bonds are back, baby.” To borrow the enthusiastic declaration made by Jason Alexander’s character George Costanza in the hit ’90s sitcom, Seinfeld. 

Bonds will say: “We have decent yield, and we are starting to do our thing again, delivering ballast in portfolios.” 

Maybe the classic balanced portfolio isn’t dead—there are signs of life. 

In October 2022, Jonathan Chevreau asked: The 60/40 portfolio: a phoenix or a dud for retirees? 

On my blog, Cut The Crap Investing, I recently updated the returns for the core ETF model portfolios. The returns have been solid, from January 2016 to October 2022. 

That’s not too shabby, considering 2022 has been the worst year on record for balanced portfolios. Bonds have been hit hard along in most stock markets. Stocks and bonds typically don’t like high inflation, and bonds especially, as they go down in price when rates are increased to combat inflation. 

On the plus side of the ledger, yields (in the 4% range) from bond exchange traded funds (ETF) are now quite attractive. And if rates do continue to rise, funds will be spring-loaded with even more attractive yields. 

We “expect” two things from bonds: yield and an inverse correlation to stocks. As I’ve written for MoneySense many times, that inverse relationship (convexity) is not a guarantee, even though it’s the norm we’ve lived through over the last four decades. 

There is an increasing likelihood that bonds will do their thing if we get a recession or enough economic weakness. Rates get cut in recessions to spur economic growth. Bonds are still likely to provide that recession hedge. 

Keep in mind, if you want less price risk you will use shorter-duration bond funds like BMO’s ultra-short ETF. You will get more risk along with more convexity with a bond market ETF or a longer-duration ETF like the BMO Long Federal Bond Index ETF, ticker ZFL. 

Certainly GIC rates (guaranteed investment certificates) haven’t looked this good in a decade. You may decide to use a combination of GICs and bonds to manage risks. 

Fixed income is back. But readers will know, given ongoing inflation risks, I am still a fan of all-weather balanced portfolio models. You’ll also find that approach in ETF form, in the Advanced Couch Potato Portfolios. 

If you’re in the accumulation stage with time on your side, stick to your plan and invest money on a regular schedule. 

Dale Roberts is a proponent of low-fee investing, and he blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge for market updates and commentary, every day. 

About Dale Roberts

Dale Roberts is a former investment advisor and proponent of low-fee investing. He created the Cut The Crap Investing blog in 2018. Find him on Twitter for market updates and commentary, every day.

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