Big mistakes, rising rates, salami fakes October 17, 2022 Made in Canada IN THIS ISSUE Welcome to TLDR’s first quarterly markets edition! We’re doing something a bit different this week: we’re unpacking — with charts, razor-sharp analysis, and expert insights — what the heck happened in Q3 (July 1 – Sept. 30) and why. There’s a lot to get to, and only some of it is about salami. Let’s go! —The Editors Q3 REPORT CARD S&P 500 -5.3 (-24.8 YTD) TSX -2% (-13.6% YTD) DOW -7.6% (-18.4% YTD) BIGGEST GAINER ERO Copper Corp. ($ERO)* WINNINGEST SECTOR Consumer Discretionary: 5% (Energy: ~29.8% YTD)* OUR FIVE MOST-TRADED STOCKS $HND, $AVCT, $HUT, $CMC, $TTOO** *Universe: S&P TSX Capped Index **Based on DIY Wealthsimple customer trades by number of shares bought or sold, excluding penny stocks. Q3 HAIKU Last week, we asked TLDR readers to summarize the quarter in verse. Our pick for the best submission: Buy the dip, they say Nine dips later, I’m back in My mom’s basement suite —Jenni C TINY TAKE STEPHEN POLOZ, former Bank of Canada governor and author of The Next Age of Uncertainty, recently told TLDR: “I think the best path we can hope for is a stagflationary one — a slow or flat period for a year or two as inflation moderates. That said, people need to understand that, because of Russia’s war against Ukraine, energy markets have been altered perhaps permanently, or at least for a long time. So energy will cost more but food could as well since it’s connected. That’s not inflation; that’s just a higher price forever, and we’ll have to adjust.” THE BIG IMPORTANT STORY #1 PORTFOLIO Why the Asset Bubble Popped, All at Once By Philip Grant TLDR asked Philip Grant, associate publisher of Grant’s Interest Rate Observer — a financial newsletter that was one of the first publications to warn about the 2008 financial crisis — to explain why what happened in the third quarter matters. | Illustration by Melanie Lambrick It’s the morning after in North America. The major stock indices finished the third quarter at or near bear territory, and bonds have provided no port in the storm: Bloomberg’s benchmark Treasury index shed 4.3% in Q3, bringing its year-to-date losses to a historically awful 13%. (Let’s not even talk about crypto.) This one-two punch has dealt so-called 60/40 investors — those who hold that classic portfolio allocation of stocks offset by (ostensibly) safer bonds — their worst annual showing since the Great Depression. Which has a lot of reasonable people wondering: why has this diversified, resilient portfolio failed to be, well, resilient? The Easy-Money Era Is Over Markets are, in effect, enduring a bruising hangover from a long-standing stimulus party. In the years after the 2008 meltdown, central bankers kept interest rates near zero to encourage lending and jump-start the economy. These low rates gave investors little reason to keep money in the bank, since zero rates meant zero interest payments. Cash was trash. Growth trumped profitability. Savers suffered, while borrowers basked in cheap money and low credit stress. The result was a decade-long bonds-and-stocks frenzy that, in time, fomented a giant asset bubble — one that grew during the pandemic. Last year, by one measure, stocks reached their most expensive levels, relative to earnings, since the dot-com days. Demand for bonds, meanwhile, was so strong that a record $18 trillion of global debt slipped into the Upside Down, meaning that investors, desperate to put their money anywhere but in the bank, were willing to pay more for a bond than what they would receive when it matured. Buy $100 now; get back $95 in five years. But the thinking went that maybe the bond prices would appreciate with a little luck. Interest Rates Triggered a Reckoning Now, raging inflation has forced central bankers to sharply raise interest rates to slow the economy. These higher rates have crushed stocks that soared during the zero-rate era, particularly those of fast-growing, unprofitable tech companies, like Shopify (down a cool 80% this year) or DoorDash (-70% YTD). Meanwhile, bonds, which have historically risen when stocks slide, haven’t dampened the blow, since rising rates pushed investors to hoard cash in (now juicy) savings and money-market accounts. Could Q4 ... Be Worse? As markets limp toward the 2022 finish line, one big question is whether policymakers will throttle back their rate-hiking campaign to control inflation. The U.N. has already called on central bankers to halt rate hikes to avoid a global recession. And high borrowing costs will constrain government spending, perhaps testing policymakers’ inflation-curbing resolve. So far, though, neither the Fed nor the Bank of Canada have signalled an end to the hikes and likely won’t in the very near future, following another hot U.S. inflation print last week. There’s a chance that inflation could start falling fast late this year or early next, as rising rates take their toll. But, provided prices stay stubbornly high, legendary investor Stanley Druckenmiller speculated on where this leaves us: “All those factors that cause a bull market, they’re not only stopping; they’re reversing.” This quarter, in other words, could be even more sobering than the last one. In downturns (like during the Financial Crisis, below) the 60/40 portfolio tends to hedge falling stock prices. This year...? TINY TAKE THOMAS M. HOENIG, former president of the Federal Reserve Bank of Kansas City, recently told TLDR: “I hope we don’t ever return to zero rates. I tell people, ‘Do you know any good in the world that trades well at a zero price? No. So why would you expect money or credit to?’ Zero rates are the reason people invest in speculative projects that become nothing but problems.” QUESTIONABLE ACCOMPLISHMENTS 🏅 Best False-Hope Giver The Summer Rally, that sweet, delicious window from mid-July to mid-August, when the major stock indices surged 11%–22%, thanks in part to July’s lower-than-expected U.S. inflation report (and a hefty dose of wishful thinking). 🌟 Best Salami-Related Scam Your Hometown Deli. Remember that Jersey delicatessen that never turned a profit and yet had a US$100 million valuation? Well, three cold-cut accomplices were indicted for (allegedly) inflating the stock in a bid to create a lucrative-looking shell company that would eventually merge with a bigger company to help it go public on the cheap and sly. 🏆 Best Sponsorship-Loser Hockey Canada, once the source of so much Canadian pride (and the drainer of so many parents’ discretionary income), botched its handling of sexual-assault allegations, which included using registration fees as hush money. The scandal has tainted the brand and, we dare say, the national pastime. In response, Every. Single. Major. Sponsor of Hockey Canada has jumped ship. HONOURABLE MENTIONS 🏦 Best Anxiety Causers: Jay Powell & Tiff Macklem 🛥️ Best Wealth Vaporizer: Three Arrows Capital ⚾ Best $250K-Ball Misser: Blue Jays fan Frankie Lasagna SHARE TLDR WITH YOUR FRIENDS 🤝 Put this link in your group chats, your Slack threads, tattoo it on your back — whatever works for you! THE BIG IMPORTANT STORY #2 ASSETS The Story of the Stock Market, Told by Five Companies By Sarah Rieger Illustration by Melanie Lambrick For more than a decade, high-growth stocks soared. But when the era of easy money ended (see above) that trend reversed quick, with profitable, slower-growth companies suddenly outperforming speculative investments. Here are five stocks that tell that and the market’s other prevailing narratives this quarter. THE PANDEMIC UNICORN Peloton ($PTON) wasn’t the only company that did a boom-and-bust pandemic cycle, but its tumble has been the most Icarus-like, with its stock down an apocalyptic 90% since this time last year. Like other pandemic darlings (👋Shopify), it benefitted big time from customers stuck at home with extra cash. But, when life returned to normal-ish, sales slumped as costs skyrocketed. Other pandemic favourites have suffered similarly: Wayfair is down 91% from its pandemic high. Zoom: -87%. Docusign: -85%. In May, Peloton reported a US$757 million loss. Earnings expected: Nov. 3. THE TECH GIANT Meta ($META) rode a wave of growth and cheap money to glory: from May 2012 to September 2021, its stock climbed a bananas 1,180%. Then digital advertising slumped, thrusting Zuck & Co. into a strange new, less profitable world. As a result, $META is down a painful 62% YTD. And tech stocks have tanked broadly. The ARK Innovation fund — deep on Tesla, Roku, Spotify — sits -77% from its peak, and the tech-heavy Nasdaq (-34% YTD) lags the other major indices. Why? Basically, higher interest rates slow growth, and growth is tech’s entire MO. Higher rates also incentivize investing in companies that spit out a lot of cash, and tech companies aren’t famous for that. Meta is now c̶u̶t̶t̶i̶n̶g̶ ̶c̶o̶s̶t̶s shifting vibes. Earnings expected: Oct. 26. THE NEW VALUE STOCK Apple ($AAPL) is a tech company in that it makes gadgets and apps, etc. Yet it rakes in cash (it generated US$23 billion in free cash flow last quarter) and has strong margins and loyal customers to boot. These qualities, some argue, resemble those of a value stock. For the uninitiated: value stocks (think: oil or banks) don’t necessarily grow like crazy and for that reason tend to be undervalued. But for the price they’re reliable moneymakers and thus relatively resilient. Value stocks have fallen 17% YTD, compared to the more precipitous drop of growth stocks, which have slid about 35%. Apple has split the difference, sinking only (“only” being relative in ’22) 23% YTD. Earnings expected: Oct. 27. THE ENERGY EMPIRE Suncor ($SU), in normal times, would likely be reeling right now, after a boardroom shake-up and the resignation of its CEO. But normal times these are not. A global energy crunch, courtesy of Russia’s war against Ukraine, means energy companies basically can’t go wrong. Suncor’s stock, shake-ups be damned, is up 36% YTD. Surging commodity prices have placed Canadian oil and gas companies squarely among the TSX’s top performers, and industry watchers say demand is likely to stay high at least in the short term. Earnings expected: Nov. 2. THE MEMESTOCK Bed Bath & Beyond ($BBBY) shot up in early 2021 during the first big memestock fever. $BBBY’s wild ride, like so many speculative investments’, should have ended when rates rose and markets retreated. And yet August saw a memestock revival, during which $BBBY (briefly) shot up 300%. Like meme hysterias of yore, the frenzy, which also included r/wallstreetbets mainstays $GME and $AMC, was basically driven by hype and Reddit chatter. But this time, the energy just wasn’t the same, and $BBBY stock is now trading about 70% lower than where it started the year. ($GME and $AMC crashed back to Earth too.) Earnings expected: Jan. 5. TINY TAKE TREVOR TOMBE, economics professor at the University of Calgary, recently told TLDR: “I would be skeptical of anyone who says they know which direction stocks are going to go ... The worst might be behind us inflation-wise. But the effects of rate changes won’t really begin to manifest themselves in the economy until early next year.” 🤔 SO WHAT HAPPENS NEXT? The short answer, like always, is no one knows. But for next week’s edition, we’ve asked a few know-it-alls to opine a little and explain what they’re watching closely in Q4 to gauge where markets are headed. One of those people we asked was Stephen Poloz , the former BoC Governor, who told us that he suspects rising prices for, well, everything may have had a cooling effect that’s “at least equal to 100, maybe 200, basis points of interest-rate tightening” — and, as a result, inflation could fall faster than some forecasters anticipate. And that would help investors a bunch. More on what to expect in next week’s issue. TLDR STORIES YOU MIGHT HAVE MISSED ⚡ What Happens When Russia Turns Off Your Economy? A Q&A about Europe’s ongoing energy fiasco 🏭 The Chipmaker at the Center of the Taiwan-China Standoff, and Global Trade An expert discusses the geopolitical significance of a semiconductor powerhouse 📉 Our Four-Step Plan to Investing in a Crappy Market How to stay smart when markets go south THOUGHTS ON TODAY’S ISSUE? Love it Good So so This newsletter’s contributors: Brennan Doherty (interviews), Sarah Rieger (staff writer), Melanie Lambrick (illustrator), Elise Assenza (senior designer), Jeshurun Webb (brand design lead), Jared Sullivan (senior editor, writer), Kat Angus (managing editor), and Devin Friedman (editor-in-chief). The quotes for the Tiny Takes were edited for length and clarity. Wealthsimple Media Inc. 80 Spadina Ave Suite 400 Toronto, ON, M5V 2J4 Replies to this email address are not monitored. 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