Taking on the biggest issues investors are talking about these days: inflation and the U.S. debt ceiling.
In his Q3 update, Simon begins with an interesting fact: Inflation is not something that exists outside the financial system – it is the system. Inflation is so much a part of the system that the Bank of Canada’s (BOC) mandate is to contain inflation between 1-3%, with a 2% target rate, by manipulating the cost of borrowing.
With a series of policy decisions now behind us, Simon feels there is good reason to believe higher interest rates initiated by the BoC are working to lower inflation. From an inflation-high print of 8.1% in June of 2022, to a more recent reading of 4%, inflation is subsiding, leading him to believe the Bank will likely start reducing interest rates soon.
On the U.S. Debt Ceiling
Simon notes that the cap that was designed to stop Congress from overspending has not worked. From a debt limit of $1 trillion set in the 1970s to the north of $30 trillion cap that exists today, the debt limit has been raised 78 times since the cap was established in 1917. And while there is cause for concern about the total amount owed, the bigger concern surrounds the emergence of an alternative reserve currency. If this were to arise, it could lead to countries like China not extending credit to the U.S. in the future.
Simon sees optimism for the bond market. Today, investors are not only receiving a healthy yield, but there’s also the opportunity for capital appreciation as rates come down. As inflation continues to moderate, the need for higher rates will end. Precisely when that will happen will depend on the stubbornness of inflation and whether or not we see a big R recession or a small R recession. Accordingly, investment-grade bonds represent a far better total return proposition than at any time since the Global Financial crisis.
Simon notes that the third quarter was negative for stocks and for most asset classes with risk. From here, he believes the base case for equities may be some short-term pain but expects great prospects in the middle distance. If we see a recession, we expect that recession to be met with action from the U.S. Federal Reserve in particular, taking policy rates lower, which is more accommodated for credit, good for markets, and great for stocks.
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