• Market leadership has been shifting under the surface for a few weeks now but things came to a head in recent days.
• Tech leaders had an outsize impact on the S&P 500 on the way up, and we are seeing them overcontribute on the way down as well.
• The average U.S. stock and the TSX have seen more subdued returns in 2024, and recent volatility has been felt much less outside of technology.
• Investors have been lulled into a sense of security as volatility has been subdued - U.S. stocks had their longest stretch without a 2% daily loss since 2007.
• Sectors of the market that have been left for dead such as dividend stocks and the Canadian market in general are seeing a renewed sense of optimism as rate cuts in the U.S. come into focus while the Bank of Canada delivers its second rate cut.
• One bright spot has been continued USD strength, insulating Canadian investors’ U.S. holdings to some degree.
• Corrections are normal and healthy, but never feel that way when we are living through them.
• Given the outsized reactions we are seeing to relatively minor earnings misses, we feel this bout of volatility presents an opportunity for investors, with the most recent economic news out of the U.S. still suggesting growth.

Earnings season brings fireworks to the market’s high flyers…

After a quiet start to the summer in equity markets, the start of the U.S. earnings season has brought volatility back to the forefront after a long vacation. Indeed, the S&P 500 just ended its longest streak without a 2% loss in a single day since 2007. Leadership in markets has been shifting quietly beneath the surface for a few weeks now, but it became obvious for all to see in recent days as investors’ beliefs in the everlasting momentum of all things technology took a hit. Just as the large weight of technology companies had an outsized impact on the S&P 500 on the way up, they are punching above their weight on the way down, overstating the moves we can expect to see in a typical balanced portfolio.

… but the impact elsewhere is more muted

Just as the TSX and average U.S. stock in general, and dividend stocks in particular, have not seen the same upside as technology, their reaction on the downside has been more muted. In some instances it has been outright positive as the prospect of lower central bank interest rates renews interest in dividends, rewarding patient Canadian investors. With the Bank of Canada putting forth its second rate cut this week and the first rate cut out of the U.S. appearing imminent, the market is wasting no time in pricing in what the world might look like when bond yields are falling once again. A second order impact here has been continued USD strength versus the loonie, which has had the effect of subduing the volatility seen in U.S. holdings for Canadian investors.

Corrections are normal, but don’t feel that way in real time!

As we write this, the S&P 500 and TSX are yet to hit official correction territory of a 5% decline, but the tech-heavy NASDAQ is already there and there is no doubt that the price action in some stocks feels very much like a correction. It is very normal for investors to worry about corrections, and just as normal for their advisors to tell them that they are part of a healthy market cycle. And they are. We tend to see a 5-10% correction each and every year, and this year has been notable for its lack of volatility as mentioned above. The thing about corrections is they never feel normal when we are going through them! Each and every time there is a litany of reasons as to why this is not a normal correction and is in fact the start of the next nasty bear market, an observation that is only possible to make with the benefit of hindsight.

As always, volatility breeds opportunity

In our view, investors started to view many of the market’s most powerful trends as “sure things” that were immune to the problems that typically plague normal stocks from time to time. In recent days, doubts have started to creep in, and when a stock priced for perfection collides with an outlook that tilts to any degree less positive, the subsequent repricing can be violent. What we find interesting is that we have seen stocks that were quite reasonably valued sell off sharply on decent, if not great earnings reports. At the same time the most recent U.S. GDP report was ahead of expectations and unemployment remains low. This tells us that investors are in “shoot first and ask questions later” mode, exactly the types of mispricings that long-term investors can take advantage of.

 

The Harbour Group

416-842-2300

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