Knowledge Centre

Q3 2023


Faced with soaring inflation and one of the steepest interest rate hike cycles in history, investors have been bracing for the recessionary shoe to drop. Yet a strange thing happened on the way to this highly anticipated global slowdown: an equity bull market broke out earlier this year. It moved in starts and stops; but the trajectory has been upward. Many investors and market pundits tend to focus on backward looking economic data, while stock markets are forward looking so, they miss headlines that are far more important to the financial markets, like; “the global economy has likely shifted toward a higher for longer period for peak interest rates.” The summit looks to have been reached and a pivot is possibly imminent.

Canada’s economy slowed in the second quarter after solid first quarter growth and has been flat for the last few months. The Bank of Canada has likely moved to the sidelines and seems willing to forego further interest hikes, after 10 increases since March 2022 pushed rates to a 22 year high of 5.0%. Its next move is likely to be a cut. The current slowdown is largely driven by temporary shocks such as strikes and wildfires. Manufacturing is recovering; real estate seems to have stabilized; and service industries are still going strong. Given the record pace of immigration, job growth has been exceptionally strong. Canada appears to be on a path to steady, if slower, growth.

Despite concerns of an economic downturn, the U.S. economy has been strong especially considering rising interest rates. After 18 months and 11 interest rate hikes, the U.S. Federal Reserve appears to be nearing the end of its tightening cycle. Inflation is steadily cooling from once painful highs. The labour market remains tight even if there are signs of easing while wages grew at a slower pace. Consumer spending remains steady due to excess savings that were built up during the pandemic. All this leads to confidence in a likely soft landing economic scenario.

Europe’s economy has grown modestly after months of stagnation, but higher interest rates designed to fight inflation are casting a shadow as they make it more expensive to borrow, invest and spend. The European Central Bank has unleashed ten straight hikes to knock down inflation, pushing rates to a record high of 4.0%. Fortunately, inflation continues to gradually decline but a deepening downturn in business activity points to more pain ahead. The Bank of England has made 14 rate increases in the most aggressive U.K. tightening cycle in decades but better than expected growth, falling energy prices, lower post-Brexit concerns, and a buoyant financial sector might have turned the tide.

Japan remains the holdout as its peers tighten monetary policy to fight high inflation; however, an exit from accommodative policy is almost at hand. Wages continue to rise, pushing up inflation and driving the Japanese yen down over 12% this year. China is seeing slowing demand as a property crisis, weaker manufacturing and foreign demand, and rising youth unemployment have derailed its economic recovery.

Many markets have generated double digit returns at some point this year, but most have come back to earth recently. Canadian equities fell 2.2% in the third quarter but are still up 3.4% for the year. U.S. equities have gained 13.1% year to date (YTD) and fell 1.1% in the third quarter (all figures are in Canadian dollar terms). International equites dropped 1.9% in the quarter but have gained 7.6% this year. Similarly, emerging market stocks lost 0.6% in the quarter and are up 2.2% YTD. Bonds had a very rough third quarter, falling 3.9% for a year to date return of -1.5%.

The outlook for the world economy has inched up a little bit this year as a growing number of voices are starting to see a potential soft landing across many developed nations. This “Goldilocks” outcome would be a rare achievement, especially with higher interest rates which were needed to help tame inflation from weighing on activity. Luckily for us, it seems that just as one new impediment rears its ugly head, a resolution presents itself that tilts the downside risk into a slightly brighter future.


For most of the third quarter the Canadian economy has been flashing mixed signals with flat GDP growth in July along with a cooling job market. Preliminary data for August and September did not align with a strong rebound and the economy seems on track to underperform during the third quarter. Consumer spending, particularly on goods and retail sales, has been the primary driver of the negative momentum on the backdrop of staggering household indebtedness. Although disposable income has been outpacing the growth in debt, the household debt level per capita in Canada is the highest of any G7 country. Coupled with lingering inflation, households are struggling to maintain their purchasing power and decreased consumer spending appears to be the natural fix for personal finance restructuring. Also, the Bank of Canada’s (BOC’s) tough’s stance on inflation and a longer than anticipated period of elevated interest rates will likely keep the GDP growth low.

In the third quarter, the S&P / TSX has lagged for the most part. July gains quickly evaporated with returns of -1.37% in August and -3% in September, on the backdrop of rising rates. Government of Canada and U.S. Treasury bonds yields have risen above 4% and 4.6% respectively after decades of ultra low rates. The TSX closed the quarter with a 2.2% loss although it is still in positive territory with a 3.4% gain year to date (YTD). The bulk of the S&P / TSX losses were in Telecommunications and Utilities with 13.2% and 13% quarterly losses respectively. Although Energy gained 19.3% and Health Care was up 16.3%, single digit losses in all other sectors weighed more heavily on the S&P / TSX in the third quarter. The energy sector had seen deteriorating prices for months as China’s growth disappointed but the recent voluntary production cut by OPEC and Saudi Arabia’s unilateral 1 million barrel output reduction per day has revived the sector. Despite energy prices surging 30% from their latest lows, the energy stocks did not fully capture this upside as many energy investors in Canada and North America remain wary of the future of the fossil fuel industry in light of the electric car industry picking up pace after record breaking sales in 2022.

The high expectations for the S&P / TSX a few months ago on the basis that surging yields would propel value stocks over growth stocks has yet to materialize. The pullback in the third quarter following a resilient first half occurred while the index exhibited tremendous value in some of its largest segments. Financials, for example, have been underperforming the index with a 2.3% quarterly loss despite its 32% weighting, value bias, and higher favourable rates environment for banks. There has been a renewed interest in Energy with oil prices pushing through $90 per barrel.

The recent spike in rates has been the key headline and risk factor in global markets and will likely remain at the center of market gyrations as the fourth quarter unfolds. Entering 2023, the “most anticipated Canadian recession” (a term coined by some analysts) has not occurred but still casts a shadow as the year draws to a close. Weak GDP readings of the last few months seem to indicate that the economy has embarked on a rough patch with lower growth ahead. The BOC’s “one and only” policy directive to keep inflation within the 2% range will likely continue to support an environment of higher rates and lower consumer spending. Thus the economic conditions in the coming months seem to exhibit catalytic factors for a slowdown and the beginning of a new cycle.


Bonds continued their slide in the second quarter of the year, with the FTSE Universe Index returning -3.9% for the quarter, bringing its YTD return to -1.5%. A recurring theme for 2023 persists as rising yields continue to test investor patience. Yields continue to notch higher as Canada and other global economies battle inflation. After seven straight months of decline, Canada’s core inflation rate ticked higher in July and August.

Real return and long term bonds were hit hardest by rising interest rates as they have a higher duration and are more sensitive to rate changes. Interest rate sensitive treasury bonds were also beaten through the quarter. High yield, corporate and short-term bonds were less impacted by interest rates as their performance is more closely tied to issuer credit quality and short term rates. Credit spreads remained steady for the quarter and as a result, bank loans continued their momentum thanks to healthy corporate fundamentals amid persistent consumer spending.

Rates were kept steady through the quarter, following ten rate hikes since March 2022. In July, The Bank of Canada (BOC) noted that there is still excess demand in the economy, so it increased its GDP forecast and extended the expected timeline of inflation normalizing back to the BOC target rate of 2%. Not the most encouraging words for a market looking for a soft landing to avoid a recession. Given the sticky nature of inflation, future rate hikes are entirely possible.

Like its neighbor, the U.S. Federal Reserve’s latest decision was to keep its interest rates unchanged at 5.25%-5.50%, and it also indicated that interest rates could increase one more time this year. A growing consensus that rates will stay higher for longer has dashed hopes of aggressive rate cuts in the near future. The average contract interest rate for 30 year fixed rate mortgages jumped to 7.53% as of September 29th. This makes mortgage rates in the U.S. their highest since November 2000 and a full percentage point higher than it was one year ago. Long term bonds fell because of higher rates and increased supply. To raise cash, the Federal Reserve issued more long term bonds, further driving down bond prices and increasing yields.

This is an example of the type of decisions and trade offs central banks need to make in an inflationary environment. Increasing the interest rate deters spending in an effort to combat inflation. However, the resulting higher rates reduce a business’ ability to make capital expenditures and stops consumers from taking out loans and purchasing goods. A higher interest rate doesn’t have to be solely a bad thing. Raising interest rates attracts foreign capital looking for higher yields, supporting the country’s currency.

There is reason to be optimistic as the slope of the dreaded inverted yield curve is less steep than it was just a few months ago. It is a general consensus in markets that the longer the yield curve is inverted, the higher greater the odds of a recession, so a flattening yield curve is encouraging. All eyes will be on yields and inflation expectations moving forward. The economy is in good shape with a strengthening work force, and persistent consumer spending but it is still running too hot. Investors would be wise to stay patient as the current restrictive monetary policy will need take time to prove its effectiveness. Any sign of future rate cuts will likely spring the market forward.


U.S. equities came back to earth in the third quarter returning -3.7% bringing its YTD return to a positive 11.7%. In September the S&P 500 had its second consecutive month of decline following five consecutive months of gains. The rising price of oil led to the Energy sector leading the market for the quarter (+12.7%) followed by Communication services (2.5%). Oil prices rose to over $90 per barrel for the first time since November 2021. This was the Energy sectors best quarter since Q4 2022, the last time that growth underperformed the overall market. The remaining nine sectors all finished in the red for the quarter. Grumblings of interest rates staying higher for longer saw a spike in bond yields, diminishing the first half rally in the stock market. The Federal Reserve’s latest move was to keep its interest rates unchanged at 5.25%-5.50% and it indicated that interest rates could increase one more time this year.

After an elven consecutive month of relief from inflation, it ticked back upwards in both July and August as consumer spending marches on and people go back to work. Inflation and the consequential rising interest rates continued to be the primary theme for the quarter and their impact was clear in the indices performance as Utilities (-9.3%) and Real Estate (-8.5%) finished the quarter as the worst performing sectors in the market. Real Estate stocks in particular are receiving the brunt of growing investor sentiment that high rates really will be in effect until the battle with inflation is won. The average contract interest rate for 30-year fixed rate mortgages jumped to 7.53% as of September 29th. This makes mortgage rates the highest average rate since November 2000 and a full percentage point higher than it was one year ago.

Utility companies tend to utilize leverage to a greater degree than companies in other sectors in order to finance their capital expenditures so as rates continue to climb, their expenses can increase drastically, shrinking margins. Investors tend to switch out investments in Utility companies with bonds or high interest investments. Capital intensive and highly levered companies continue to face the brunt of higher interest rates while their counterparts with clean, strong balance sheets will be beneficiaries.

The S&P 500 is a market cap weighted index, and the top ten constituents make up nearly a third of its overall composition with large cap growth stocks, “magnificent seven” (AAPL, MSFT, AMZN, NVDA, GOOGL, META & TSLA) leading the way. These names largely underperformed for the quarter with an average return of -2.3% after an incredible first half to 2023 in which they had an average return of 79.6%. Tesla and Meta aside, these high growth names made up 78% of the entire U.S. markets gain, a remarkable concentration. In contrast, value stocks led the market in Q3.

The outlook for equities will depend on how long interest rates stay high. The stock market was riding high in the second quarter off the perception that rate increases were nearing an end and encouraging inflation expectations. Now the market must deal with more persistent inflationary pressures stemming from wage inflation and persistent consumer spending at a time where monetary policy is aiming to be more restrictive.

There is good news! Despite an uptick over recent months, the slope of the dreaded inverted yield curve is less steep than it was just a few months ago. It is a general consensus in markets that the longer the yield curve is inverted, the greater the odds of a recession, so a flattening yield curve is encouraging. For the U.S. stock market to continue its 2023 rally, a broadening of positive performance is required. The index is top heavy and the large cap, growth-oriented portion of the market has played its part, but the ebbing of consumer prices is the required catalyst needed to continue the U.S. markets strong year.


The global economy has dodged a couple of bullets this year. Spiking energy prices, collapsing foreign currencies and the ongoing war in Ukraine have continued to roil markets. On the flipside, labour markets remain strong, corporate earnings have stabilized, economic growth stayed positive and consumer spending has been remarkably resilient. The major headwind continues to be interest rates, not only with their elevated levels but also the fast pace of the increases. Ironically, the tide of inflation surprises has recently turned in a much more favourable direction, but more twists and turns may be coming.

Fighting off an historic surge in inflation, the European Central Bank has now lifted borrowing costs by 4.0% since last Jul, and they have indicated that they will stay high as long as necessary. Nevertheless, it is increasingly clear that an end to rate increases is fast approaching as inflation fell to its lowest level in two years in September, largely reflecting sharp drops in energy prices. The past year has been a whirlwind in Europe as the economy has been pushed to the brink of recession. Manufacturing is in a deep recession while services have now also started to struggle following a brief post-pandemic boom in tourism. The labour market is still exceptionally tight with record low unemployment raising the risk that wages will also rise quickly.

The U.K. is heading for a long period of near zero growth if not an outright recession. The the only G-7 industrial economy yet to recoup the output lost during the pandemic. Britain’s departure from the EU is the likely culprit for both sticky inflation and anemic growth as it has hobbled trade and added costs to businesses. The Bank of England lifted interest rates to 5.25%, its highest level since 2008, after 14 back to back increases; although there are indications that borrowing rates have peaked. Still, growth remains fragile as the currency fell to its lowest level since late March, record growth in workers’ pay and clear signs of weakness in the housing market are minimizing any optimism.

Japan’s economic growth jumped at an annual pace of 6% in the second quarter, marking the third straight quarter of growth as exports and inbound tourism recover. A negative is that consumer spending has stalled. The Bank of Japan has exercised super easy monetary policy for years with -0.1% interest rates to jumpstart an economy beset by deflation. For the past decade, it has also used massive asset purchases to keep credit cheap in an effort to spur investment and spending, propping up growth. That has amplified inflation sharply since the pandemic. This approach has caused the Japanese yen to dramatically weaken against the U.S. dollar. They have pledged to keep supporting the economy until inflation hits its target of 2%; it has currently topped 3%.

As a whole, international equity markets have done quite well so far this year, climbing 7.6% (all figures in U.S. dollar terms), despite falling 4.1% in the third quarter. European stocks dropped 4.9% in the quarter but remain up 8.6% year to date (YTD) on the strength of gains achieved in Italy, Spain, and Ireland. Asian markets declined 2.3% in the quarter and gained 7.7% so far this year. This strength was almost exclusively on the 11.6% yearly results for Japan as its stock market hit a 33 year high offsetting the decline in Australian stocks and the 17.6% loss for the year to date by Hong Kong stocks.

Current economic conditions may be close to stabilizing. Supply chain disruptions are improving, shipping costs are declining, and inventories are in good shape. The trajectory of wages and energy prices remain uncertain but inflationary pressures are abating. Consumers will likely be more careful with where and how much they spend. A turning point for equities historically takes place when central banks start to pivot from rate increases so a large upside is possible as markets and economies normalize.


Over the past few years, the global economy has seen high inflation and almost universally tighter monetary policy while growth has remained at or just below trend. It appears a transition point is close at hand. Several major emerging market central banks have already started to ease policy but in this challenging environment just how quickly inflation levels fall is open to debate. Recent Emerging Markets losses have come alongside a surge in global volatility fueled by renewed concern over twin challenges, China, and U.S. Federal Reserve policies. China makes up roughly one third of the emerging market stock universe, so its underperformance has been a huge drag.

Despite persistent disappointments China’s economy is not fundamentally broken. China’s economic woes have been brewing for years spurred by structural forces such as an aging population and soaring government debt. Of course, at the heart of China’s economic turmoil lies an escalating real estate crisis since real estate accounts for 30% of economic growth and up to 70% of household wealth. Additional challenges such as record youth unemployment; deflation; weak consumer sentiment; bank lending falling to its lowest level since 2009; and tepid growth in retail sales while household savings have risen, paint a bleak picture. Over the past two decades China’s economy has been maturing and focusing more on domestic consumer spending while reducing its reliance on exports and manufacturing.

Nobody lives in a vacuum; we are surrounded by others who see turbulence and try and step into the void. As such, there has been a shift of supply chains away from China to other countries. For example, if only one tenth of China’s manufacturing moved to India, it would double the size of the Indian manufacturing sector. India is one of the fastest growing economies in the world and is poised to continue this path. Its second quarter economic growth was 7.8%. With the Reserve Bank of India remaining hawkish as the risk of inflation is only now starting to recede, growth down the road could weaken.

In other emerging market countries conditions are worrisome. Turkey is experiencing galloping inflation and an exodus of foreign money so the central bank is lifting its key policy rate to 19.5%. Agricultural production and thus economic growth in Indonesia and Thailand are expected to be hit by dry weather in the coming months due to the El Nino effect. Russia is reinstating capital controls and raising interest rates sharply as its economy crumbles. Currencies have been tumbling in countries such as Hungary, Poland, and Sri Lanka, that have started to cut borrowing costs.

In Latin America the focus is shifting from the economy to security in many cases. Argentina and Ecuador, two serial defaulting nations, are both amid presidential elections with investors left guessing about their future. In Argentina, overseas bonds have tumbled since a leading candidate for the presidency has vowed to abolish the central bank and dollarize the economy. On a positive note, Brazil’s economy expanded after a surge in agricultural output and a lift in services activity; and Mexico has benefited immensely from more reshoring activity.

Emerging Markets are down 2.8% in the quarter and are only up 2.2% for the year (all figures in U.S. dollar terms). Latin American stocks dropped 4.6% in the quarter but remain up 13.4% for the year paced by Mexico’s 19.1% gain. European emerging market stocks gained 2.0% in the third quarter and surged 15.7% for the year. Asian stocks have been the laggards falling 2.8% in the quarter and are up a meager 1.3% for the year on the back of China’s -7.1% decline year to date.

August has turned out to be chaos for Emerging Markets. Equities have lagged developed markets as China has underperformed. After three years of COVID-19 lockdowns and isolation, China’s recovery got off to a strong start earlier this year but since that time industrial production, retail sales and real estate have all been under pressure. For the rest of Emerging Markets, risks have always been more political than economic so while fundamentals can be positive, current events can creep up and bite investors. Caution and recalibration should always be prudent watchwords for investors with a large dose of patience as well.


After a series of consecutive rate hikes, the Bank of Canada (BOC) left the policy rate unchanged for most of the third quarter amid signs of moderate economic contraction at the end of the first six months of the year. In the job market, cracks started to build up with a growing unemployment rate following months of strong job growth. In this environment of decelerating but sticky inflation, the path for Canadian future rates is hardly an easy one. The BOC’s stance and narrative seem to favour protracted elevated rates as it continues efforts to reach the 2% target inflation rate.

Canadian Real Estate Investment Trusts (REITs) started the quarter on a positive note in July but receded in August and September to close the third quarter with 6.7% loss; more than three times the broader S&P/TSX losses. Although the sector managed to hold a small gain in the first half, August and September losses pushed the year to date (YTD) return to -6.0%. Globally, the MSCI Global REIT disappointed further, losing 13.7% YTD in Canadian dollar terms. The markets have increasingly been convinced that peak rates are within reach, but central banks do not yet appear ready to shift gear into lower rate mode. The tough stance on inflation by the BOC and global central banks has been the primary reason for the strong spike of volatility in Canadian and global yields. For REITs, this environment of sustained policy tightening has been detrimental to operations in the form of a higher cost of capital, reduced capital markets activities, and ultimately lower valuations. Though these headwinds have not translated into distressed property sales in Canada, they do create serious challenges notably in the office subsector.

The national office subsector continues to detract most from the REIT index with double digit vacancy rates. CBRE (a Real estate services and investment company) estimates that the Canadian office vacancy rate reached its highest level since 1994 in the second quarter. But Colliers (another Real estate services and investment company) indicates that office vacancies could peak by 2024 as hybrid work gains popularity with more people returning to the office a few days per week. South of the border, there is also a deteriorating outlook for offices amid ongoing pressure on costs, valuation, and fundamentals. A recent survey by Bloomberg revealed that U.S. investors see elevated risks of a steep crash in the office sector. There is about $1.5 trillion of commercial real estate debt set to mature by 2025 in the U.S. alone. Regional bank lending, already under stress from the latest crisis, will be highly constrained for most debt renewals.

Fortunately, subsectors such as Industrial and Residential continue to be resilient with no apparent weakness in sight. For instance, investors in the residential segment in Canada are well positioned in this cycle. The sector faces an outstanding imbalance between supply and demand with a $1.2 trillion housing supply gap in the rental market causing skyrocketing rents. Home ownership and housing affordability show little signs of easing as 50% of Canadian renters do not believe they will ever own a home. The federal government’s deployment of $20 billion towards low cost rental financing should help increase supply. However, the shortage is a long term challenge and current housing fundamentals are more favourable to investors.

REIT underperformance across the board appears overdone as the bulk of the headwinds have been concentrated in the office sector. Canadian REITs are trading at attractive discounts to their Net Asset value (NAV) while in the U.S., the sector has fallen about 30% from its 2021 high because of higher interest rates. There is growing sentiment that the correction is finding a bottom and the sector presents an attractive entry trade for opportunistic and patient investors.

Contact Us

  • * Denotes Mandatory Fields