We hope that you enjoy the latest Chart Attack report, highlighting some of our key economic charts to keep an eye on. We have outlined below our thoughts on a few charts that stood out to us.

The past few years have been nothing short of interesting for the financial markets, and the volatile swings in forward P/E (valuation) levels demonstrate that well. We can see that over the past year, most markets have seen their valuation levels contract after marking significant highs in 2021. The US saw its forward P/E level drop from roughly 24X down to 21X, and the Canadian markets saw a drop from roughly 18X to 14X. Canada’s current P/E levels of ~14X are in line with its average P/E of 14X. Valuation levels contracting do not necessarily imply stock prices declining, as an increase in expected earnings (EPS) can also cause P/E multiples to decrease. Over the past year, we have seen a significant rise in future expected earnings, and this partially explains the decline in valuation levels.

The 10-year bond yield dropped to a historical low in 2020 and has since been on a steady incline, nearing 2.0%. Meanwhile, the TSX dividend yield fell from its pre-pandemic levels of roughly 3.0% down to 2.56%, as the TSX climbed, and the dividend yield fell. Many investors have their eyes on these two trends, as a flip in the TSX dividend and 10-year bond yields can have several implications for the risk-reward tradeoffs of bonds against equities.

Inflation continues to be a widely discussed topic for 2022, as recent inflation prints have been breaking multi-year records. Canadian headline inflation reached a record high over the past ~16 years, touching close to 5%. These record levels of inflation have been brought on by fiscal and monetary stimulus, allowing for increasing levels of consumer spending. Supply chain constraints have also contributed to curbing the supply of consumer products. While transitory inflation is no longer in the picture, we do not believe that inflation will remain elevated at these levels forever, just as they have ebbed and flowed over the past 16 years. Specifically, we are looking for an easing in the supply chain constraints coupled with tighter monetary policies to cause a decline in the levels of inflation.

High levels of inflation have historically caused central banks to increase interest rates, in efforts to disincentivize consumer spending and borrowing. Uncertainty around the magnitude and length of interest rate hikes in 2022 and 2023 are causing investors to seek safety and sell-off their high-risk, high-growth assets. We believe that if inflation begins to ease, investors’ worries of increasing interest rates may begin to subside as well.

The 10-year less 2-year government bond yield spread is a measure used in predicting recessions. Once the 10Y-2Y spread turns negative, as can be seen in 2000, 2007, and in 2019, a recession has followed each occurrence within 6 to 24 months following. A negative 10Y-2Y spread means that the yields on 10-year bonds are less than on 2-year bonds, indicating that investors anticipate interest rates will decrease over the long-term and increase in the near-term.

The yield spread has been decreasing over the past year, and ideally, we would prefer to see the spread find a bottom here and begin to increase again. This would imply either an increase in the 10-year yield, a decrease in the 2-year yield, or a combination of both. If the expectation for near-term rate hikes begins to soften, we may see the yield spread begin to find a bottom.

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