The economy so far in 2023 has been remarkably resilient, although cracks are starting to show. We’ve seen an absolutely massive increase in interest rates, almost five full percent from the 0% rate earlier in 2022. We’ve seen a tightening of domestic monetary conditions. We’re starting to see the beginning of a credit crunch set up. Already in Europe we've now printed the second quarter of growth below zero.

Whether you want to call that a recession or not, the tightening is evident there. That's no growth and we're likely to see a further loss of growth into the end of 2023 in the United States and Canada. In our own forecast, we think you'll pass through a mild recession in the second half of this year, mild to mid, and emerge sometime in 2024.

But peak rates of growth for this year are likely being seen as all of these tightening agents are now biting on the economy.

Well, the war on inflation is being won, but it is being won at a cost. You know, consider the slide into recession that we're likely to see as being collateral damage from winning that war. A year ago, June of 2022, inflation in the United States poked above 9%. It's now below 5% and we think headed towards 4% by Christmas of this year.

Later in 2024, there's a real chance you could achieve 2.5% percent for North American inflation rates. They’re getting awfully close to the 2% that typically anchors central bank targeting. The tightening of interest rates, the rise in interest rates tightening down the money supply, all of these are coming together to deliver the lower rate of inflation, but again, at a cost.

Until recently, central banks could been single-mindedly focused on inflation. The level of job creation was simply unsustainably high. Wage growth was starting to reflect that. And if anything, some moderation in the economy was a good thing. So central banks raised rates, not just the United States, but elsewhere, tighten down the rate of growth in the money supply and have been delivering lower levels of inflation.

However, the huge increase in interest rates in particular, comes at a cost. The difficulties we’ve had in regional banks is a great example of that, it is not uncommon to periods towards the end of a cycle of tightening. So we think that that cycle is now delivering the goods and that the peaking of interest rates is at hand in most countries and particularly in the United States.

Maybe there's another 25 basis points of hike, maybe 50. It'll be data dependent. But we're peaking in interest rates near here. We'd expect a plateauing as the full force of tightening feeds through the economy, plateauing into 2024. As we move deeper into 2024, we could actually start to see the beginning of interest rate relief. Call it a quarter or maybe even a half of 1% of rate relief from the peaks of 2023.

Well, the first time in many quarters we find the fixed income market showing reasonable or even attractive levels of valuations. We've been quite concerned as real interest rates sunk and held at negative levels, and as the nominal interest rates weren’t offsetting the rising inflation rates, that was evident in 2021, 2022 and into 2023. All that's changed.

We're now 3.5% percent or so on a 10-year bond yield in the United States [or] not far below that. In Canada, we actually reached as high as 4% earlier in the year. So for the first time, the opportunity in the fixed income market looks to be quite interesting to us. In fact, that has broader implications for portfolio construction that one might want to think of. At 0%, fixed income securities don't do much for you in a balanced or multi-asset portfolio.

They don't provide you anything in the way of cash flows. And you now have a very long duration asset; a highly volatile asset that's probably positively correlated with equity risk. When you move back from 0% towards that 3.5% level that you’re at, you have a coupon that’s meaningful, cash flows into portfolios, and you have an offset with a volatility that's more likely to come in equity markets.

So, much more attractive market. A market that has greater utility in portfolio construction than we've seen in several years.

The stock market extended its gains through the second quarter of 2023. Its resiliency is actually quite remarkable given the things that have happened around it in the economy. However, when you focus on individual stock markets or even within individual stock markets, a very different story emerges. So we see Japan is now up in the double-digit range, but China is stuck.

China is stuck because the economy is having difficulty mounting a durable recovery. Even in the United States, where year-to-date you're up something like 9%, there's really two groups, a big one and a small one. You have about seven stocks called the Fab Seven. You have Amazon, Apple, Microsoft, NVIDIA, and they're up quite strongly, responding to the AI and other excitement in the technology part of the economy.

But the rest of the list – most other stocks are actually down less than that on the year and many of them actually down, the unweighted averages are down something like 2% against the cap-weighted averages, which are up something like 9%. So there is really this two-tier stock market going on.

A two-tier stock market largely reflects pressure on profits. Many companies are now responding to lower revenue growth, margin pressure, and a slowing economy. Their own costs have been rising and it looks like negative earnings growth for 2023 and quite mild earnings growth for 2024.

So that's holding back equity markets and I think making it vulnerable to further correction or correction down the line as recession actually takes hold later in the year. In this kind of murky environment where you have reasonable valuations but real threats to earnings going forward, it doesn't feel like the right kind of situation to add a whole lot of risk into equity portfolios.

So over the quarter behind us, we've actually neutralized our equity positions, reduced those positions or the risk taken in those positions towards our long-term neutral level, and taken that balance and added it to bonds and left our asset mix essentially at long-term neutral positions.

Having a neutral position, essentially not having risk in multi-asset portfolios, is a very uncomfortable situation for asset managers.

We look to add to our returns through tactically managing above or below these neutral positions over time. But with the murkiness we see going forward, it doesn't seem like an appropriate time to add or deduct. So what would cause us to add to equity positions? We ask ourselves this a lot, so we feel free to do it when the situation actually presents itself.

The first thing we'd want to see is an easing of financial conditions. We'd want to see rates peaking, at least, if not coming down. And we want to see some of the restrictions taken off the rate of growth of the domestic money supply. We'd certainly want to see the end of the threat to credit in the economy. So not so much an easing of credit conditions, but no more tightening of credit conditions with an eye towards the next step, being an easing.

And then within the stock market, we're quite concerned about the narrowness of the advance. So while the index is going up, very few stocks are following it in that direction. We want to see that index broaden out and validate the movement upwards that we've seen. So at least those three things would be required for us to add to our equity position.