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The Bank of Canada building in Ottawa in May 2017. Concerned about inflation, this week the Bank of Canada started raising interest rates again.CHRIS WATTIE/Reuters

O, happy days! This week, the S&P 500 finally emerged from its bear-market funk and entered bull-market territory, meaning it has gained 20 per cent from its recent lows in October.

This is genuinely good news. However, it is equally valid (and maybe a bit more insightful) to say that all the world’s leading stock-market index has managed to accomplish in recent weeks is to claw its way back to where it stood two years ago. There have been epic peaks and valleys along the way, but no lasting gains.

Investors may want to keep that in mind as they contemplate what to do next. Yes, software breakthroughs like ChatGPT are exciting and, yes, employment has remained surprisingly strong in both Canada and the United States, but neither changes the big picture.

Central banks are still determined to wrestle inflation to the ground, come what may. Their inflation-fighting efforts will probably involve a recession or at least a significant slowdown.

The question is when. Until the timing and size of any slowdown becomes clearer, markets will be trapped in a waiting game, Deutsche Bank argued in a report this week. It expects a painful U.S. recession to start in the fourth quarter of this year but it acknowledges the profound uncertainties around any forecast. When it asked an audience of 1,200 money managers and corporate executives at a recent fixed-income conference when the next recession will start, opinions were all over the board.

About one in five respondents said the recession will begin this year. Nearly half said some time in the first half of next year. To complicate matters even further, more than a quarter indicated that the downturn will be so mild it won’t ruffle markets.

To sum up: Nobody knows.

The pervasive lack of clarity was underscored this week when the Bank of Canada surprised markets by resuming interest-rate hikes. Earlier this year, the central bank had called a halt to such increases. At the time, it said the economy was starting to slow and that inflation was trending back down toward the central bank’s 2-per-cent target.

Oops. Rather than slowing, the economy continued to roar ahead in the first quarter. In April, inflation ticked higher, not lower. The Bank of Canada was forced to acknowledge in a statement on Wednesday that “concerns have increased” that inflation could “get stuck materially above the 2-per-cent target.” So it decided to make a U-turn and start raising interest rates again.

When will the bank stop the pain and actually start chopping rates? To reiterate: Nobody knows.

Inflation is proving harder to eradicate than markets or central bankers had bargained on. Like the Bank of Canada, the Reserve Bank of Australia surprised markets by boosting its key interest rate this week. A growing number of people think the U.S. Federal Reserve will follow suit either at its meeting next week or at its subsequent meeting in July.

For now at least, central banks are signalling that they are willing to do whatever it takes to get inflation back to their 2-per-cent target. The big question is whether they accomplish this without hammering the economy into a full-scale recession.

The answer – and stop me if you’ve heard this one before – is that nobody knows.

Some prominent observers, including Goldman Sachs and the Institute for International Finance, argue that the U.S. will escape a downturn and manage a soft landing despite its current inflationary woes.

Other well-known institutional investors, including BlackRock and Deutsche Bank, say that’s nonsense. They argue that the rapid-fire interest-rate hikes of the past year are just beginning to take their toll and will inevitably lead to a hard landing for the economy and the stock market. “The U.S is heading for its first genuine policy-led boom-bust cycle in at least four decades,” Deutsche Bank wrote in its World Outlook this week.

For investors, perhaps the most useful takeaway from all this back and forth is to remain skeptical of easy generalizations. Sure, it is nice that a new bull market has started (at least, if you measure such things by the popular 20-per-cent rule of thumb). But that doesn’t mean you have to rush to load up on stocks.

There are at least three reasons to stay cautious. First, stocks aren’t cheap in either Canada or the U.S. when measured against their long-run ability to generate earnings. Second, stock markets usually don’t bounce sustainably higher until central banks start chopping interest rates. Third, policy makers seem determined to slow their economies until inflation has been unquestionably beaten.

The wisest course may be to keep in mind Deutsche Bank’s waiting-game analogy. It will most likely take several months for the economic picture to clarify. Until then, investors may want to favour the safe and boring – short-term bonds, dividend stocks, residential real estate investment trusts (REITs) and the like.

If this is a new bull market, there will be plenty of time to jump into more exciting areas. And if it’s not? You will be happy to be conservatively positioned.

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