Market and economic commentary
January 2023

The year kicked off with a strong rally from both fixed-income and equity markets. Headline inflation continues to trend downward while unemployment rates remain at or near multi-decade lows. The Bank of Canada raised its target short-term rate by another 25 basis points to 4.5%, while the US Federal Reserve (Fed) also hiked its rate by 25 basis points on Feb. 1. Messaging from the central banks acknowledges the hikes take time to have an effect, and that the banks will consider if the increases already made in 2022 are achieving the intended outcome before raising rates again. 

Below are index total returns in Canadian dollar terms for January¹:

S&P/TSX Composite Index: 7.4%
S&P 500 Index: 4.7%
MSCI EAFE Index: 6.5%
FTSE Canada Universe Bond Index: 3.1%

While both the Bank of Canada and Fed raised rates, the Bank of Canada was notably less “hawkish” than its US counterpart. Bank of Canada Governor Tiff Macklem signaled a pause in rate hikes, and a desire to assess the impacts before further hikes are considered. Compared to earlier last year, when the question was “how much” rather than “if” rates would be increased, this indicates a shift in policy that will likely see the bank resistant to further hikes unless growth or inflation picks up substantially.

Canadian inflation data for December was released in January, and shows all major price categories fell with the exception of food and shelter. Energy led the way down, falling just under 8%, resulting in overall inflation dropping 0.6% and hopefully continuing the downward trend that started November. The Bank of Canada’s pause on rate hikes should also help steady the cost of shelter (a significant share of the consumer price index basket, a key measurement of inflation) as mortgage interest costs stabilize for homeowners, which will potentially flow through to rents.

While it’s always hard to pinpoint the reasoning behind shifting market sentiment, the thought of rates cresting and potentially even easing later this year seem to be the main driver behind the market rally this month. Despite the Bank of Canada raising its overnight target rate, the bond market has already been pricing in higher probabilities of cuts later this year. Bond yields as a result came down about 0.3%² for the month lifting prices, and ultimately driving positive returns for this asset class. Investment grade corporate bond spreads also narrowed slightly for the month, which indicates the market’s willingness to take on risk.

Within the ATB Investment Management funds, both our fixed-income and equity holdings were up overall on an absolute basis as the market reacted positively to moderating monetary policy. The fixed-income holdings within the Compass Portfolios and ATBIS Pools didn’t see as much of a price lift from falling yields with shorter-maturity holdings than the overall market, but did benefit additionally from narrowing spreads. Overall, the component gained about 2.5% lagging the longer-duration index by about 0.6%. While it may seem attractive to extend the duration of our bond holdings to go along with the market trend of lower expected future rates, we remain defensive. Should core inflation remain stubborn and prompt central banks to maintain current rates, mid- and longer-term yields could rebound higher. We aim to mitigate some of that potential downside volatility by keeping a shorter duration. The yield to maturity continues to be our main driver of expected return, and as of month end, sat at roughly 5.8%.

Within equity markets, all regions were up in absolute terms for the funds over the month ranging from about 3.5% for the US equity holdings, to 6.5% for the Canadian equity holdings. Canadian equity holdings lagged the S&P TSX Composite by about 1% largely attributable to not holding Shopify, and an underweight in mining companies. US equity holdings lagged the S&P 500 by about 0.8% where some of the largest contributors to performance were Tesla, and Apple—both of which are underweight in the funds. Small- and mid-cap, which are both overweight in the funds, performed better than large-cap, offsetting some of the relative underperformance. International equities added 4.6% for the month, but underperformed by 1.9% on a relative basis primarily due to an underweight to European banks—an area of the market that our sub-advisor Mawer has not been keen to chase due to a long history of poor capital allocation decisions and disappointing long-term returns³. Small-cap international stocks also lagged, which contributed to some of the negative relative performance.

^{1  Source: Bloomberg}

^{2  FTSE Canada Universe Bond Index yield to maturity}

^{3  MSCI Europe Banks net total return index annualized returns of 4%, -3.8%, 1.1%, and 1.3% for 1, 5, 10, and 20 year periods respectively ending Jan 31, 2023.}