The warning signs of an approaching recession are now impossible to ignore. But Canadian investors are giving it their best shot.
As the lagged shock of elevated interest rates on the domestic economy starts to take shape, the precursors to a downturn are falling into place.
The Canadian government bond market, for example, is flashing red, with longer-term yields falling below short-term yields by the widest margin since the harsh recession of the early 1990s.
The Canadian stock market, on the other hand, is having a great year. It may not feel like it, considering the TSX has been swept up by the same corrective forces that have befallen every major stock market in the world.
But the sell-off here has been conspicuously mild. The S&P/TSX Composite Index is off by less than 6 per cent year to date – a garden variety dip compared with what’s happened to U.S. stocks. The S&P 500 index is down by 17 per cent, while the Nasdaq Composite Index has lost 30 per cent.
Canadian bond market raises the alarm
new subhed: Government of Canada 10-year minus two-year
bond yield (basis points)
300
200
100
0
-100
-200
1990
2000
2010
2020
the globe and mail, Source: canaccord genuity
capital markets
Canadian bond market raises the alarm
Government of Canada 10-year minus two-year bond
yield (basis points)
300
200
100
0
-100
-200
1990
2000
2010
2020
the globe and mail, Source: canaccord genuity
capital markets
Canadian bond market raises the alarm
Government of Canada 10-year minus two-year bond yield (basis points)
300
200
100
0
-100
-200
1990
2000
2010
2020
the globe and mail, Source: canaccord genuity capital markets
To outperform U.S. benchmarks by any margin is rare enough. The TSX has managed that feat just once in the last 11 calendar years. To do so by more than 10 percentage points hasn’t happened since 2005, when the commodity boom was gaining power and resource stocks caught a major updraft.
Canada has strength in commodity prices on its side this year as well. But that’s where the similarities end.
Start with the inversion of the yield curve, which is considered a credible indication that tougher times lay ahead. Under normal circumstances, the longer a bond’s time to maturity, the higher the yield to compensate investors for taking on additional risk. But that relationship tends to flip as economic strains coalesce.
“Beware the yield curve’s warning,” Sal Guatieri, senior economist at BMO Capital Markets, wrote in a recent note. “It’s not a perfect guide to downturns, but one of the most reliable. Ignore it at your peril.”
Other hallmarks of an impending recession have materialized of late. Canadian manufacturing activity is slowing, while inventories relative to sales are building.
The Organization for Economic Co-operation and Development’s composite leading indicator for Canada, which blends together a variety of measures from money supply to consumer confidence, has been declining all year.
Similar strains are intensifying around the world. “The 2023 global recession should be highly synchronized,” Martin Roberge, a portfolio strategist at Canaccord Genuity, wrote in a recent note. A survey of professional forecasters by the Federal Reserve Bank of Philadelphia pegged the odds of a U.S. recession at nearly 45 per cent – by far the highest reading since the survey started in 1968.
A Canadian downturn is an even stronger bet – closer to 65 per cent, said Jimmy Jean, chief economist at Desjardins Group. With higher levels of household debt, the Canadian economy is extra sensitive to aggressive rate hikes.
Still, the Canadian stock market remains a haven of sorts. Many analysts did foresee a decent year for the TSX. It is a market light on speculative and richly valued growth stocks, which have borne the brunt of the U.S. sell-off. A shift in investor preferences toward value stocks and resources has played to Canada’s strengths.
Confidence in the relative standing of Canadian equities seems to be undaunted by a worsening economic outlook. “The stock market is much more on the fence as to whether there will be a recession,” Mr. Jean said.
Earnings expectations for next year have been mostly spared from the kind of mass revision consistent with past recessions. For companies in the S&P/TSX Composite, the Bay Street consensus forecast is for a 5.2-per-cent increase in profits in 2023 – roughly the same as the outlook at the start of the year, according to Refinitiv data.
U.S. recession fears spiking
Probability of shrinking real GDP in the year ahead
50%
45
40
35
30
25
20
15
10
5
0
1970
1980
1990
2000
2010
2020
Note: Shaded areas are recessions
the globe and mail, Source: Federal Reserve Bank
of Philadelphia
U.S. recession fears spiking
Probability of shrinking real GDP in the year ahead
50%
45
40
35
30
25
20
15
10
5
0
1970
1980
1990
2000
2010
2020
Note: Shaded areas are recessions
the globe and mail, Source: Federal Reserve Bank
of Philadelphia
U.S. recession fears spiking
Probability of shrinking real GDP in the year ahead
50%
45
40
35
30
25
20
15
10
5
0
1970
1980
1990
2000
2010
2020
Note: Shaded areas are recessions
the globe and mail, Source: Federal Reserve Bank of Philadelphia
Usually when macro concerns spoil overall risk appetite, preferences shift toward defensive sectors, like consumer staples, telecoms, and utilities. That hasn’t happened. In fact, those sectors have underperformed the rest of the Canadian stock market since the summer, Mr. Roberge said.
While many economists see a recession as unavoidable, the stock market isn’t buying it yet.
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