Central banks started raising interest rates way back in the spring of 2022. It's been such a long period with the economy holding itself together that one wonders if the window isn't closing on the threat of recession. In fact, if you look back historically, it typically takes 18 months from the beginning of a cycle of tightening until the economy passes through into recession.

We think that the risk of actual recession is increasing as we head towards year end in the first two quarters of 2024. We have that in our forecast. There are signs of the economy slowing in the United States and elsewhere. The Purchasing Managers' Index for our manufacturing activity really started to peak in late 2022 and has been coming down all the way through 2023.

And Europe is already at recessionary conditions and not far off that indicated in the United States. Problematically, China, which makes up such a large part of global growth in most parts of most cycles as has had trouble stimulating its economy after a big flourish earlier this year. That recovery has fizzled and unfortunately, debt problems in the real estate sector are once again being exposed.

In our forecast, we have the economy sliding through zero late in 2023, perhaps around Christmas, staying in a mild to intermediate recession in the early part of 2024 and finishing a year with probably less than 1% growth in North America for the full year. More difficult times ahead for the economy as the full force of monetary tightening feeds through.

Inflation's really cool through 2023, responding to tighter monetary conditions and a bit of a slowdown in the economy. It's really important to note that the early drivers of inflation, things like massive expansion of the M2/money supply, supply chain problems through COVID. They've mostly cleared M2 for example, which works on a sixteen-month lag. It’s now in negative territory, pulling inflation down towards that zero bound.

On an uneven path, we should expect there'll be good months and bad months. And as we get to lower and lower levels of inflation, the easy, the low hanging fruits have been picked, but on an even basis, you know you're heading closer to below 3 percent, two and a half percent for inflation as we move towards 2024 and beyond.

I think this has been a successful battle against inflation. A very important battle has been won. And as we look back at this period, while it's been painful and more pain is to come, that's for sure, the central banks will have restored their credibility as inflation fighters. It's so important to building balanced growth going forward.

We've been through a period of historic rate hikes in terms of size, intensity and time. It was a necessary thing to do that given the spiraling of inflation and the problems that that can cause for the longer term. I actually think that if rates haven't peaked, they're very near a peak right now. Should plateau for a while into early 2024. But as the economy more visibly slips towards recession, markets that we would agree with this actually expect the Fed and other central banks to start cutting interest rates and maybe slowly as they start to build in intensity, if the economy slows more markedly than we expect later into 2024. The outlook for rates peaking, if they haven't peaked already, and it's interesting to us, that the Bank of Canada just yesterday held firm at the current level of interest rates.

It's all sort of falling into place that this long period of tightening may well be behind and heading into a plateau period before it cuts in 2024.

If in fact rates are peaking now or will peak soon, we should look for a peak in yields now as well. We're in a very active period in fixed income markets and yields will have peaked at about their most attractive level in terms of yield and valuations in many, many years.

As the economy more visibly heads into recession in early 2024, expect some relief not only on rates but yields to follow, and that will bolster coupons which are already attractive and add to our returns. We also believe that finally that at the current level of yields and that which we expect into 2024, that bonds will provide the kind of cushioning against other risk assets when blended into investment portfolios.

Well, it might appear that the stock market hasn't cared much about the monetary tightening that we've seen and the increasing risk of recession that we're heading into. But if you scratch below the surface you see a very different picture. There really is a two-tier stock market that's happened over the last year. Year to date, the Nasdaq's up 30%. The S&P up about half of that amount.

But if you take the seven largest stocks, the biggest winners out of that S&P 500 counter, that 15% return falls to something like 4%. And returns elsewhere in the world aren't much different from that level. So beyond these AI-sensitive, massive global technology stocks that have got all the bid in 2023, we see a very different stock market emerging and one that is now more concerned about valuations and the outlook for earnings that would come from a weaker 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 The re-evaluation of stocks beneath the Magnificent Seven is a good thing, but we think they will respond, though, to earnings if they do start to decline. It's quite interesting that analysts actually have given up on the recession. We saw in the last month, the consensus for U.S. earnings, for example, has actually started to rise. It's not uncommon for earnings to peak and analyst estimates to peak after recession begins.

That perhaps that's what we're seeing. In our view, a weaker economy will continue to pressure margins, which are already coming down from elevated levels. Further compression will come as pricing power has weakened and volumes fall in a weaker economy. We'd expect a tougher year for earnings in 2024. And even though most valuations are now at reasonable levels relative to current expected interest rates and inflation, slowdowns in the economy and earnings are never good for stock prices.

We'd expect, at best, single-digit returns for stocks across most countries for 2024.

We've been particularly active in adjusting our asset mix, exposure to the equity markets, fixed income and cash over the last 18 months or so. As monetary tightening progressed, and the threat of recession loomed, we progressively moved our equity exposure from overweight to neutral as the threat of falling earnings and what were higher valuations became problematic in our mind. On the other hand, interest rates, which were historically - about 150 years of history – low, we felt they were poised for a rise as real rates of interest and inflation premium were pressed higher.

That's all played out in our mind. We now have, I think, very attractive valuation underpinning for fixed income markets. Our next likely steps, if the economy does follow the track that we would expect is perhaps going slightly overweight on fixed income, although timing I think is really an issue. The threat to equities I don't think can be denied as the economy gets closer and closer to recession and earnings come under increasing pressure.

We sit with a neutral asset mix in terms of cash, bonds and stocks. We have our eye on best entry points with fixed income.