Lexicon Financial Group Weekly Update

Monday, February 14, 2022


Looking Back

Trucker convoys, blocked US-Canada border bridges, ongoing supply chain problems, Russia-Ukraine face-off, higher inflation, looming interest rate hikes, etc. It’s almost as though we can write the headlines before the week even begins.

Inflation figures actually came in higher than expected last week at 7.5% in the United States versus the expected 7.3%. As an attempt to curb inflation, central banks around the world are expected to raise interest rates. Canadian rate-makers held off in their last meeting but, in the US, rates are expected to rise at least three times in 2022. Importantly, some pundits are calling for a 50 basis point (one basis point is 0.01%, so 50 basis points is one half of one percent) rise in rates at their next meeting, which hasn’t happened since 2000.

Supply chains in Canada and the U.S. that are still trying to recover from the disruptions caused by the pandemic now face more disruption by the ongoing protests at key border crossings. This is creating shortages of some goods and increasing shipping costs. Those effects are beginning to be felt, and the Canadian government is now taking action to remove the blockades so goods and services can begin flowing freely again. Blocking of the border – most notably the link between Canada and the US at Windsor’s Ambassador Bridge – has had an impact on both economies. The estimated cost here is $300 million a day in economic damage. This should come as no surprise as about 25% of all Canadian-U.S. trade passes over the bridge.

 

Looking Around

There is a non-scientific concept that floats around financial markets in the United States early each year. It’s called the “Super Bowl Indicator”. First coined in 1978 by New York Times sportswriter Leonard Koppett, the Super Bowl Indicator goes like this: If a National Football Conference (NFC) team wins the Super Bowl, stocks should rise for the rest of the year. If the Super Bowl winner is an American Football Conference (AFC) team, stocks should fall. Congratulations to the LA Rams of the NFC on winning the big game!

So, if the result of a sporting event like the Super Bowl is a predictor of the market, stocks should fare well in 2022. Of course, market results are NOT connected to the outcome of a game. It is interesting, though. This weird sports/market coincidence has been right more than it has been wrong: 41 out of 55 times. However, it has been wrong 5 out of the last 6 seasons. And markets have actually done fairly well lately when an AFC team has won. So much for a sure thing.

It’s interesting to draw some comparisons between “indicators” like these and some of the other tidbits we see on the news. It’s getting harder to separate hard economic news from the noise. We need only look back to see how disconnected the market can be from reality. Last year at this time, we were scratching our heads wondering why people were flocking into Gamestop, a company whose business model appears outdated and whose doors were largely closed due to a pandemic.

Ultimately, rather than relying on indicators, we believe that fundamentals and logic are a better path to long-term financial and investment success.

 

Looking Beyond

A hike in interest rates is imminent as inflation is showing no signs of subsiding in the near future. To put interest rates into context, please see the chart below which shows interest rates as measured by the annual value of the US Federal Funds Rate – the target interest rate set in the U.S. Historically, the average interest rate between 1955 and 2021 was 4.64%. We haven’t seen rates like that since the financial crisis in 2008.

 

Federal Funds Rate -- 62 Year Historical Chart

Source: Macrotrends

This chart shows the daily level of the federal funds rate from 1954 onwards. The Federal Open Market Committee (FOMC) meets eight times a year to determine this federal funds target rate. As of last week this rate was 0.08%.

Given this we can see that essentially we have a generation of investors and savers who have experienced ONLY historically low interest rates.

In March this will change as interest rates are expected to increase by at least 25 basis points or a quarter percentage point. As you may know, there is a relationship between stocks (especially growth stocks) and interest rates. The bond market is 10 times larger than the stock market. Yes, the debt market is that gigantic. If interest rates continue to move up and pass a certain threshold, investment in stocks moves to bonds because it provides a safer yield and enables de-risking. Investors will need to reset rate of return on their investments for the first time in more than a decade.

The cost of borrowing will rise due to interest rate increases and these costs will be passed onto consumers and businesses. This dampens demand thereby reducing inflation but it also dampens economic activity. There are implications, but thinking more long term is what should be remembered by investors and savers alike.

 

Further Reading

Markets & Investing – Raymond James

A Normal Supply Chain? It's 'Unlikely' in 2022

Fed's Bullard says the central bank's 'credibility is on the line,' needs to 'front-load' rate hikes

Stocks slip on Wall Street with eyes on Ukraine crisis

Understanding inflation: CPI increases and the Causes

 

The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.

 

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