To my clients:

It was an up week for North American stock markets with the Canadian TSX finishing up 0.9%; the U.S. Dow Jones Index finishing up 1.6%; and the U.S. S&P 500 up 1.7%.

As I wrote in my quarterly letter to discretionary clients (sent this morning), receding tariff concerns and a Fed imminently set to lower rates further (per Fed Chair Jerome Powell’s speech this week), there is support for a continued rise in stock markets. However, as I also wrote, in my opinion the biggest driver will be continued growth in corporate earnings. Corporate earnings have, year-to-date, been growing at a handsome pace that has exceeded analyst’s estimates. Q3 reporting season kicked off this week and, so far, this solid trend continues, with U.S. banks setting a positive tone on the back of better than expected results across almost all lines of business. Hopefully this trend continues as earnings season continues the next few weeks.

Now, while I do believe earnings will be the main requirement for continued upward market momentum, it’s not that the other tailwinds don’t matter, and I want to return briefly to Fed Chair Jerome Powell’s comments earlier this week. Somewhat overlooked in his comments was the important nugget that ‘quantitative tightening’ was coming to an end. While he didn’t use precisely those words, the implication was the same. Recall that during the Great Financial Crisis (GFC) of 2008, then Fed Chair Ben Bernanke utilized a little know policy called quantitative easing to help quell market panic and provide support for the economy. Quantitative easing (QE) was a tool whereby the Fed bought massive quantities of long-term government bonds thereby forcing the bond prices up and, crucially, lowering the interest rates received for those bonds and setting a lower long-term benchmark rate for the economy as a whole (it’s a weird relationship but the takeaway is that if bond prices go up, interest rates go down… it’s a purely inverse relationship). This went on for many years and QE was often cited as a main contributor to the strong market results the decade after the GFC. Some viewed the QE program as steroids for the economy and some also claimed the market and economy became addicted to the stimulus over the many subsequent years. However, in mid-2022, the Fed acknowledged that this program could not continue indefinitely and it embarked upon “normalizing” its balance sheet by implementing the reverse policy of selling bonds (thereby lowering bond prices and raising interest rates – remember that inverse relationship). In other words, quantitative tightening (QT) had begun – and in keeping with the steroidal analogy, one could think of QT as depressants for the economy. after more than 3 years of this so-called tightening, the Fed will be winding down the program and neither easing nor tightening will be employed moving forward (as was the case the very vast majority of the time prior to 2008). So no, the economy will not go back to using steroids, but at the same time it will be ridding itself of depressants. All else equal, this is a supportive step for the economy and markets.

Oh, and by the way, President Trump, in comments to the press within the past two hours (during a press conference with Ukrainian President Zelensky) mentioned that he still intends to get together with President Xi of China and he thinks a more comprehensive trade deal with China will get done. This dials down the rhetoric delivered late last week and sent markets which were flat before the news conference into a solidly strong close to end the day.

Now, all the preceding is positive. However, there were some negative developments this week, notably credit concerns in the private credit and leveraged loan markets. This is an esoteric part of the financial markets not normally available to most retail investors, and a part of the market that I as a professional portfolio manager have elected NOT to utilize for clients [mostly owing to the opaqueness of the market and ‘liquidity’ concerns (i.e. the ability to access your money when you want it) that arise from time to time]. Without digging in the weeds, the developments this week have echoes of the GFC and the situation bears watching. But I will emphasize that ALL strategists whom I respect and admire agree that these echoes are weak at best, and the issues are likely to be well contained. Nonetheless the situation bears watching.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569
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