‘Buy the Dip’

Markets had a cow Tuesday. The poor S&P lost a couple of percentage points shortly after careening to a new record high. What happened?

US inflation came in hot. Mr. Market wanted a headline number with a 2-handle. Instead it was 3.1%. Core inflation inched up a little. No disaster. Still a win for the Fed. But all those who had speculated on lower-sooner for rates were confronted suddenly with high-longer. Some even whispered higher-maybe. And down she went.

“It was good,” my suspender-snapping, BNN-enabling portfolio manager colleague Ryan said, gazing out at the smoky financial rubble from the safety of his bank-tower perch. “We needed this. The market blew off some froth, but there’s no doubt what the direction will be.”

Corporate profits have been ducky of late. Eight in ten firms have surpassed estimates. Market gains have been broadening away from the Magnificent Seven (Apple, Amazon, Nvidia, Meta, Tesla, Alphabet, Microsoft). The American economy continues to grow robustly (3.3% in the latest quarter) while unemployment is ridiculously low – sub-4% for two years now.

All that helped fuel the S&P. But so did a widespread belief the Fed would pivot. Cuts were coming, everyon cried. Inflation was being squished. Until the data came in steamy Tuesday morning.

Said veteran stock guy Ed Pennock: “Inflation is up. WTI is up. The Vix is up. NVDA was up most of the day. As opposed to the R2K which was crushed. Higher rates for longer will stress these smaller companies. Inflation hasn’t been beaten was the markets’ conclusion.”

And this is his take: “We don’t agree. Here’s the pullback that so many predicted. Time to act? we think so. Buy the Dip.”

So Mr. Market has given up on a March rate cut by the American CB. The odds today are 91.5% that the Fed will stay on pause. The odds of a quarter point chop in May are currently 37%, and of another pause, 59%. The chances of a reduction in June are now over 77%. And the odds of cheaper rates by July are 92%.

Why would the Fed reduce its policy rate when the economy’s toasty?

Simple. To keep it that way. To ease he financial burden of debt-servicing costs on the consumer, who accounts for almost 70% of economic activity. To drop the cost of corporate financing so employment can remain robust. And to reduce the crippling burden on taxpayers of government borrowing charges. Once inflation drifts into the 2% range – which the market is convinced will occur in the coming months – then the CB will slowly let the air out.

Meanwhile many people believe our guys at the Bank of Canada may trickle rates lower before the Fed moves this summer. Our economy has cooled faster and further than that of the States. Unemployment here is edging towards 6%. Debt-service charges are fast becoming the greatest (and worst) expense of the federal government. High rates have basically frozen new housing development since construction loans are hard to get and cost a fortune. This is thwarting Ottawa’s attempt to solve the housing crisis that bedevils it.

If you harbour any doubts, just check out what PM-in-waiting Chrystia Freeland had to say yesterday about what her next budget (expected in a few weeks) will prioritize:

“We definitely are conscious as our priority, when it comes to economic policy, of acting in such a way that creates conditions that will make it possible for interest rates to come down.”

Yup. She did it. Stuck her nose into monetary policy and sent a clear signal to Tiff over on Wellington Street that the feds expect (and want) the cost of money to drop. And while his job is to ignore the politicians and follow the data, this gives a little signal of what may be to come: a drop in Canada prior to that in Washington. We little beavers clearly have a more pressing need for rate stimulus than do the Yanks.

In fact on Monday the housing minister, poor Sean Fraser, said exactly that s a prelude to Chrystia’s commitment yesterday. High rates are obliterating the feds’’ big push to build millions of new homes, he admitted. And he expects that to change.

“Don’t ignore the impact that interest rates have on restricting supply. My expectation is if we see a dip in interest rates over the course of this year, a lot of the developers that I’ve spoken to will start those projects that are marginal today, but will actually pencil out six months from now if interest rates were to take a dip.”

You see the trend. Political pressure. A clear signal to the CB.

What’s the likely impact of all this on Canadians’ fav asset, residential real estate?

The latest CREA stats show ‘signs of recovery’ over the last two months with the number of deals increasing. “Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers; however, in areas where sales have shot up most over the last two months, prices are still trending lower. Taken together, these trends suggest a market that is starting to turn a corner but is still working through the weakness of the last two years,” says economist Shaun Cathcart.

By the way, the average national price, says CREA, is up 7.6% year/year. And here is the comment on what comes next from BMO Economics: “We’ll see how pent-up demand and more listings interact once spring breaks. For now, market sentiment has been buoyed by the prospect of Bank of Canada rate cuts and helped by a drop in fixed mortgage rates. That said, market pricing for Bank of Canada easing continues to get pushed out (we believe around mid-year, not in time for the spring market), while 5-year GoC yields have quietly risen by more than 50 bps since the start of the year.”

So, Tuesday’s stock market slaughter was likely overdone. And probably a good thing. The cowboys got bloodied. The bargain-hunters moved in Wednesday morning to mop up. So predictable.

As for rates, houses and Chrystia, it looks like the die is cast, doesn’t it?

About the picture: “Hi Garth: So my daughter Stayr woke up to see her dog Cash looking at her like this,” writes John. “Hard to know what he wants to discuss.. but you can tell .. whatever it is.. it’s serious.”

To be in touch or send a picture of your beast, email to ‘[email protected]’.