Five Thoughts on Global Markets

Markets are moving fast these days, and in a different direction from the one that we have all gotten used to over the past two years. In light of that, I wanted to share five thoughts on where we’re at, and how we got here. By the time you read this, there is a good chance that at least some of what I’ve written below (writing on May 9) might seem dated.

Here are five big picture thoughts on what’s been going on:

An Incredible Run

It’s still incredible to look back at how quickly the stock market bottomed in the very beginning of the global pandemic. On March 11, 2020, the World Health Organization (WHO) declared a global pandemic, Donald Trump suspended travel between the US and Europe, and the NBA shut down its season indefinitely. Over two years later, we’re still dealing with the impact of that same global pandemic at a societal level. COVID might feel long gone if you’re drinking in a bar in Miami, but it remains front and centre if you’re living through the lockdowns in Shanghai. With that context in mind, I don’t think anyone on March 12, 2020, would have anticipated what the stock market would do over the next two years.

The stock market bottomed on March 23, 2020 -- less than two weeks after the events described in the above paragraph. Although we’re still dealing with the implications of COVID two years later, it only took two weeks for the stock market to get over the initial fear and collapse and begin moving up again. From March 23, 2020, until the end of 2021, market returns were nothing short of spectacular, with the S&P 500 going up 113% in that period. Obviously, the bounce back from the COVID-induced decline was part of this gain, but any way you look at it, the stock market more than doubling in 21 months is still remarkable and something not seen since the rebounds off Depression lows in the late 1930s.

Nothing Lasts Forever

Anyone who started investing in their newfound spare time over the last two years may have gotten the impression that markets only go up. And there were a lot of these new investors – a Charles Schwab survey showed that 15% of current retail investors began investing in 2020. The arrival of 2022 has put this notion of “one-way markets” to bed. The S&P 500 is down 17% so far this year (as of market close on May 9), and it feels like the consensus opinion on what the rest of the year will hold for stocks is as bearish as it’s ever been. (Hmmm – maybe that’s a buying opportunity?)

Even more remarkable is that fixed income markets – often a safe haven when stocks fall -- have been hit just as hard in this year’s selloff. The drop on Bloomberg's Global Aggregate Bond Total Return Index over the first four months of 2022 was a staggering 12.42%. As the below chart shows, the previous worst year on record was 1999 with a -5.17% return.

Stock market corrections are obviously nothing new, but it’s doubly difficult when fixed income falls at the same time. If you can be down over 12% in the space of four months in what is supposed to be the safe part of your portfolio, it can really begin to feel like there is nowhere to hide.

The Return of Inflation

If you had told me at the end of 2019 that we would be living through persistent high single digit inflation rates in the first half of 2022, I simply would not have believed you. I probably also would not have believed that we would have a global pandemic during that same timeframe. I guess the takeaway is that things can change quickly, and you should never fully dismiss the possibility of something occurring just because it seems unlikely at the time. From here on out I will assume the only certainty in life is that each Spring the Toronto Maple Leafs will lose a first round playoff series in heartbreaking fashion.

US CPI hit 8.5% in March 2022, marking the highest rate of inflation since 1981. Canada has been slower to reopen post-COVID, but our inflation rate reached 6.7% and is forecasted to go even higher when the April data comes out. It turns out that taking unprecedented monetary and fiscal policy steps to address the economic impacts of a pandemic does eventually do something beyond just juicing the price of stocks and houses. When you flood the system with unprecedented amounts of money, and maintain interest rates at rock bottom levels for sustained periods, eventually the bill comes due.¹

Interest Rates Matter

After spending the latter half of 2020 clinging to the idea that rising inflation was transitory even as it persisted and climbed, central bankers now find themselves in a tough spot. As opposed to gradually being able to move interest rates off their historic lows, the Federal Reserve, Bank of Canada (and other central banks) now have to take a more aggressive approach in an effort to keep the inflationary cycle from spiraling out of control.

Both the BOC and the Fed hiked interest rates by 0.50% at their most recent meetings. This may not seem like much to a casual observer but hiking by two full quarter points in one meeting represents the most drastic upward move by either central bank since the year 2000. Beyond these moves, the consensus expectation is that we will see several additional interest rate hikes over the course of 2022 and into 2023. Overnight rates started 2022 at 0.25% in both the US and Canada, and we could easily be at 2.50% (or higher) in both countries by the end of the year. We have not witnessed interest rates at this level in the US or Canada since before the 2008 financial crisis.

What Goes Up Must Come Down

Central bank interest rates of 2% to 3% might not seem very high, but a 2.50% interest rate is 10x more than the 0.25% rate that we’ve lived with since March 2020. The effect this has on the real estate market, for instance, is axiomatic – if fixed and variable mortgage rates are 2.25 percentage points higher than they used to be, monthly mortgage payments get more expensive, and demand for housing falls.

What’s less intuitive is the impact that interest rate increases have on certain high growth tech stocks. The financial writer Morgan Housel described this phenomenon as follows:

“All valuations are a number from today multiplied by a story about tomorrow. When interest rates are zero the story part is way more influential.”

The corollary, of course, is that when interest rates are NOT zero, the number part becomes much more influential. We’ve witnessed this shift in the YTD performance of several of the high-flying high growth tech stocks of 2020-21. I’ve listed five well-known names below along with their YTD performance in 2022 (as of May 9), and how far they’ve fallen from their all-time highs.

1. Tesla -34% (36% off all-time high in November 2021)
2. Amazon -36% (42% off all-time high in July 2021)
3. Meta (Facebook) -42% (49% off all-time high in September 2021)
4. Netflix -71% (75% off all-time high in November 2021)
5. Shopify -72% (79% off all-time high in November 2021)

That gets me to over 1,000 words without even having time to touch on the biggest story of the year from a geopolitical and long-term historical perspective. Russia’s ongoing invasion of Ukraine is a human tragedy, and an international crisis that threatens to make everything I’ve written above less relevant. It’s definitely exacerbating the global inflation problem, but it feels heartless to focus on that aspect of the conflict when innocent people are dying every day. The conflict has also exposed, for those who didn’t already know, the true character of Vladimir Putin. If you’re interested in learning more about Putin, and some of the brave people risking their lives to go after him, I’d recommend watching the incredible new documentary Navalny, or reading Bill Browder’s recent book Freezing Order.