Thoughts from our Portfolio Advisory Group on global markets and key development 

June 28, 2024 - We provide a brief take on the year that’s been and our thoughts on what lies ahead.

Global equities have been somewhat directionless over the past few weeks. One notable development was the Canadian inflation report for May, which was higher than expected for the first time this year. This has moderately reduced expectations for a July rate cut, though markets still anticipate another one to two cuts from the Bank of Canada through the remainder of the year.

It's hard to believe, but we have reached the year’s midway point. Below, we take the opportunity to reflect on this year’s developments and share some thoughts on the outlook. We also want to highlight the Global Insight Mid-Year Outlook, published by some of the thought leaders across our firm. The special report on U.S. debt is particularly thought-provoking, though the whole piece is worth a read.

There has been encouraging progress on inflation this year, albeit with different regions seeing different rates of decline. Yet, services inflation has remained sticky throughout most of the developed world thanks to wage growth, resilient demand, and shelter-related costs. Even so, fading pressures have allowed a few central banks to begin cutting rates, while others, like the U.S. Federal Reserve, suggest cuts remain a possibility later this year. On the growth front, things have been arguably better than anticipated, given many investors were expecting a recession to have already begun in various jurisdictions. The manufacturing sector has been generally weak, offset to a large degree by the services side of the economy. The consensus view is that a soft landing, where the economy slows but avoids a material deterioration in employment, is now more likely for many economies, particularly the U.S.

The backdrop above has driven global equity markets higher this year, with the U.S. leading the way. But, as has been the case for some time, U.S. gains have been heavily influenced by large-cap technology, and more specifically, anything related to artificial intelligence. This momentum may continue for some time, but a few things warrant attention.

The U.S. market has become more expensive over the past year. While valuations are more reasonable if one excludes the large “tech” stocks that have led markets, they still sit above historical averages. That may have bigger implications over the longer-term than it does for the rest of the year. Meanwhile, our confidence in the sustainability of a bull market is usually highest when gains are driven by a broad range of stocks and sectors. But that hasn’t exactly been the case this year, though there is always the possibility that market leadership could broaden, or shift to other sectors. We don’t view investor sentiment as overly optimistic yet, which can often be the case near market peaks, but it is more positive than it was a year ago, suggesting there is growing risk of some investor complacency. Most importantly, the risk of recession remains above average based on various factors we monitor. As a result, we believe the range of possibilities for equities is wider than normal despite the market strength to date.

Outside the U.S., and “tech” in particular, equity markets sit at valuation levels that are more balanced, reflecting some of the economic headwinds that exist in parts of the world. On the fixed income front, yields remain attractive in our view, and higher quality bond exposure can act as a stabilizer in portfolios in the event equity market volatility returns. Overall, our approach to managing portfolios remains a bit more cautious at this time given the range of potential outcomes. We remain committed to regular rebalancing to mitigate the risk of overexposure to any one market or sector’s idiosyncrasies.

Thoughts from our Portfolio Advisory Group on global markets and key developments

June 14, 2024

Global equities have been a bit more mixed of late with Canadian and European equities weaker in recent weeks, though year-to-date gains remain respectable. Meanwhile the U.S. equity market continues to display strength, driven by the large cap technology sector. The rest of the U.S. market has not been as strong of late which is something worth monitoring given meaningful changes in market breadth can be a harbinger of future turns in the market. Below, we discuss some takeaways from the Federal Reserve update and recent U.S. economic developments.

The U.S. Federal Reserve chose to maintain its key policy rate at a two-decade high over the past week, in contrast to recent decisions by other central banks, such as those in Canada and Europe, who decided to cut interest rates. The Fed’s decision was widely anticipated, with investors instead focused on any guidance on future rate cuts and any updated economic projections. On the former, the Fed revealed that most policy makers now predict only one interest rate cut this year versus the three that were expected earlier. However, the average number of cuts that policy makers expect for 2025 and 2026 were revised higher (to four cuts from three for each year, respectively). In other words, the Fed anticipates it may not cut rates as soon as initially planned but may eventually play catch-up. Meanwhile, its average economic growth forecasts were left mostly unchanged, while expectations for unemployment and inflation were revised fractionally higher. In his comments, Chair Jerome Powell acknowledged that substantial progress has been made on inflation over the past two years, including some encouraging readings of late. However, he emphasized the committee needs to see more progress before considering any interest rate cuts.

The other key story in the U.S. in recent weeks has been the host of economic data that painted a bit of a mixed picture for the U.S. economy. On the inflation front, a few different measures of inflation for the month of May came in below expectations, marking a positive shift from the three consecutive months of higher-than-expected inflation witnessed earlier in the year. Meanwhile, manufacturing data for the month disappointed expectations, with production and new orders falling and remaining relatively weak. Offsetting this to some degree were services-based readings which continued to exhibit strength. The monthly employment report was also relatively strong, with the U.S. adding more jobs than expected. Nevertheless, the number of U.S. job openings continues to decline from remarkably high levels, and now sits at its lowest level in three years. This latter data point suggests the labour market has transitioned from one that was overheated just a few years ago to one that has come back into better balance.

Overall, the economic releases portray an economy that appears to be on the path, for now, to a soft-landing, where growth slows enough to bring inflation back to more appropriate levels without a significant rise in unemployment. That kind of outcome may be the preferred one for financial markets as it would promote some easing in future financial conditions (ie. lower interest rates) and a potential broadening in corporate earnings growth. Nevertheless, we believe that we remain in a window of time where the range of potential U.S. economic outcomes remains wider than normal given the significant change in interest rates that occurred over the past few years. It is our responsibility to be prepared for a range of scenarios and to make any necessary adjustments to portfolios as developments unfold.

Thoughts from our Porfolio Advisory Group on global markets and key developments 

May 31, 2024 - We discuss some takeaways from the Canadian banks, the Canadian economy and its stock market performance to date.

Investor attention has turned to Canada over the past few weeks due to a slew of economic releases and earnings reports from Canadian banks. Below, we discuss key takeaways from these developments and reflect on the Canadian equity market’s performance this year, along with some thoughts on the outlook.

Over the past week, Canadian banks reported their second-quarter results. Much of the focus has understandably been on the outsized stock price reactions. Typically, any moves in the Canadian bank stocks related to earnings results are relatively tame and within a few percentage points of each other. But this time around, some banks saw substantial declines in their stock prices, while others were rewarded with meaningful gains.

We have been more preoccupied with what the earnings and management commentary suggest about the state of the Canadian economy, its consumer, and overall credit conditions. Apart from one bank, most Canadian banks reported loan losses and provisions for future loan losses in line with expectations. There continues to be an uptick in credit card and auto loan delinquencies, and some banks flagged growing vulnerabilities among certain variable-rate mortgage holders. Overall, the Canadian consumer was characterized as reasonably healthy, with pockets of stress in certain areas. We would describe the credit environment as one that continues to gradually deteriorate, but not in a disorderly or concerning manner. While this represents a headwind to the banking sector, it has been anticipated for some time and is reflected in the sector’s below-average valuation.

Elsewhere, recent Canadian economic data has not been overly surprising. Inflation continues its descent, with CPI for April down to 2.7% from 2.9% in March and 3.4% at the end of last year. Economic growth remains modest, largely driven by significant population growth from immigration. Closer examination of the growth numbers reveals that real GDP per capita has fallen over the past year and a half as businesses and households cut back on spending in response to higher borrowing costs. Both the manufacturing and services sectors have seen subdued activity over the past few quarters, with consumer demand weakening as budgets tighten and the labour market softens.

Yet, despite the soft economic backdrop and tight credit conditions facing Canadian businesses and households, Canadian equities have performed reasonably well year-to-date. This is partly due to growing conviction that inflation in Canada is on track to return to the 2-3% target range, raising expectations that the Bank of Canada might soon lower interest rates. A first cut is expected in either June or July. Additionally, strong performance across a range of commodities – including energy, copper, gold, uranium, and nickel, to name a few – has boosted the Materials and Energy sectors, which together account for close to 30% of the Canadian equity market.

Notwithstanding the gains made over the past year and a half, the valuation of the Canadian stock market sits just below its historical average. This seems reasonable given the challenging near-term domestic economic outlook. While sentiment may continue to improve with a further decline in inflation and the beginning of rate cuts, we believe a turn higher in the economic and earnings cycle may be required to drive a more prolonged period of stock price gains. Given the lagged effects stemming from changes to interest rates, we see this as more of a possibility beyond the next year.

Thoughts from our Portfolio Advisory Group on global markets and key developments

May 17, 2024 - We discuss takeaways from the earnings season and the changes that are expected as we move through the year.

May has been a noticeably better month for global markets, largely fueled by data from the U.S. A weaker pace of job growth and inflation numbers that did not show the kind of acceleration seen in prior months have rekindled hopes that the U.S. Federal Reserve may start cutting interest rates in the second half of the year. This week, we turn our attention to an important challenge facing many Canadian households: the meaningful rise in the cost of mortgages and rents.

Based on figures from a year ago, nearly 40% of Canadian households are renters and just over 60% are homeowners. Of the latter, just over half have mortgages while the remainder own their homes outright. Since the Bank of Canada began hiking rates in 2022, raising their policy rate from a low of 0.25% to a high of 5.00% today, approximately half of Canadian mortgage holders have refinanced at higher rates. This has led to a significant uptick in mortgage interest costs, which have been rising by well over 20% year-over-year. While the rate of increase in mortgage costs has slowed modestly over the past number of months, it remains one of the biggest contributors to Canadian inflation. 

According to the Bank of Canada’s recent annual Financial Stability Report (FSR), mortgage costs have driven the average mortgage debt service ratio sharply higher, from between 10 and 15% over the past decade to a level now exceeding 20%. This means mortgage holders are spending a larger portion of their income on servicing debt each month. Yet, the FSR report notes that households with mortgages have been managing the higher interest rate environment relatively well, with indicators of stress remaining below their historical averages. This resilience can be attributed to a combination of factors, such as higher incomes, increased savings, and reduced discretionary spending. 

Nevertheless, the report suggests that many households with mortgages originated in 2021 and early 2022 may face more intense financial pressure in the coming years. Home prices were near their peak back then, and mortgages were initiated at the ultra-low rates available at the time. These homeowners may encounter financial strain due to much higher payments upon renewal, compounded by holding large mortgage values relative to their incomes, and equity in their homes that has either remained stable or decreased somewhat. In other words, much of the impact of higher interest rates on mortgage holders may still lie ahead.

Renters in Canada may currently be showing the greatest signs of financial stress. The Bank of Canada report highlighted a steep increase in delinquencies on consumer debt, such as auto loans and credit cards, among borrowers without mortgages. Meanwhile, the most recent inflation data from March indicated that the increase in rent prices has accelerated to a pace of more than 8% year-over-year, the highest in decades. Multiple factors continue to drive rent prices higher, including: the higher cost of home ownership that has forced potential buyers to explore the rental market instead, low vacancy rates, and high immigration.

On a positive note, the Bank of Canada is nearing the point, potentially this summer, where it will begin to cut interest rates. This should provide some much-needed relief to Canadian households and may help to slow the increasing cost of home ownership and rent. Longer-term, the supply of housing also needs to grow meaningfully to ensure some balance between supply and demand is restored. We will explore that issue in more detail in the months to come.

 

Thoughts from our Portfolio Advisory Group on global markets and key developments 

May 3, 2024 - We discuss takeaways from the earnings season and the changes that are expected as we move through the year.

Global equity markets finished the month of April a bit lower as they digested the gains made since last October. Markets largely spent the month grappling with sticky inflation and diminishing prospects for interest rate cuts in the U.S. In the past week, policymakers at the U.S. central bank acknowledged these challenges, contrasting with other regions where officials continue to telegraph upcoming rate cuts. Below, we offer insights from the first quarter earnings season, which is nearing its completion.

Overall, corporate earnings results have been solid. The first quarter earnings in the U.S. are on track to grow by nearly 5% year-over-year, surpassing expectations. Management commentary has been predictably mixed. Some leaders have highlighted resilient consumer demand, strong backlogs, and tailwinds from reshoring activity. Others have pointed to higher interest rates, geopolitical tensions, sluggish growth in China, and a strong U.S. dollar as key challenges.

As in recent quarters, most of the U.S. earnings growth has been driven by some of the largest stocks. Prior to earnings season, the “Magnificent Seven” group of technology-related stocks were expected to see earnings-per-share (EPS) growth just shy of 40%, while the rest of the S&P 500 was projected to see an earnings decline. On average, the large tech companies have exceeded expectations but experienced muted stock price reactions in response to the results. This reflects a combination of above average valuations that already reflect elevated enthusiasm and higher than expected capital expenditures largely tied to artificial intelligence-driven efforts.

Interestingly, earnings momentum is expected to shift as we move through the rest of the year and into 2025. The earnings growth rate from the tech heavyweights is projected to decelerate, from levels that exceeded 30-40% recently, to the mid-teens. A slowing in earnings growth does not necessarily imply weaker stock prices. After all, the lower growth rates are still impressive in absolute terms. But investors may need patience as earnings grow more slowly and take more time to catch up to valuations.

Meanwhile, the “rest” of the market is expected to see an acceleration in earnings growth. Outside of tech, earnings have been suppressed over the past year by cyclical factors such as higher costs, borrowing rates, and economic uncertainty among other things. However, with growing conviction in the resilience and strength of the U.S. economy, forecasts suggest earnings will accelerate, and in certain areas, outpace the tech sector for the first time in a while.

We welcome the potential for a broadening of earnings growth and would see it as a healthy development for the equity market. Nevertheless, a shift in earnings momentum between tech and everything else could potentially lead to some changes in market leadership and bouts of higher volatility, even if temporary. Whether that transpires or not, our clients’ equity portfolios remain well-diversified, making us confident in their ability to perform, regardless of which sector or group of stocks leads the way.

 

Thoughts from our Portfolio Advisory Group on global markets and key developments

April 19, 2024 - We discuss two key developments of late: shifting interest rate expectations and the escalation in the Middle East.

The past few weeks have seen more meaningful activity across global equity, fixed income, commodity, and currency markets, marked by an increase in volatility. Two developments were particularly noteworthy. The first is a significant shift in U.S. interest rate expectations due to recent inflation data. The second concerns heightened geopolitical tensions in the Middle East, following the Iranian and Israeli attacks on each other, which has left investors pondering the potential impacts on financial markets. We discuss both below.

Nearly a week ago, Iran launched an attack on Israel using hundreds of drones and missiles, reportedly in response to an Israeli strike in Syria earlier this month that killed several members of Iran’s armed forces. While Israel successfully defended itself against the attack, it represented a notable escalation in tensions as it was the first direct attack by Iran on Israeli soil. More recently, Israel has reportedly retaliated with an attempted strike that appears to be confined to military targets in Iran. Oil prices, which tend to reflect the region’s geopolitical risk most closely, have not surprisingly been volatile over the past few weeks as investors try to gage the severity of this escalation and the risk of further destabilization in the region.

From a market standpoint, the more influential developments have been on the inflation and interest rate fronts. The U.S. inflation data for March showed that, for a third month in a row, the pace of inflation in the U.S. was no longer easing as it had for the most of last year, and in some areas was reaccelerating. The stubbornness of inflation pressures presents a dilemma for the U.S. Federal Reserve, which had earlier expressed growing confidence that it would be able to cut rates at some point this year. But over the past week, the tone has changed, with a number of Fed officials acknowledging a need for patience before taking any action on rates. Consequently, markets expectations have also changed dramatically from anticipating up to seven interest rate cuts in the U.S. just a few months ago, to now expecting as few as one to two. This recalibration has driven bond yields higher (and bond prices lower), while stock markets have also trended downward recently, albeit relatively calmly, as investors grapple with the prospect of prolonged higher rates potentially affecting growth and corporate earnings. 

Meanwhile, the U.S. dollar has rallied against most other major currencies, including the Canadian dollar. There is a growing view that central banks in Canada and other regions may start cutting rates by the summer, while the U.S. may not act until later this year at the earliest. That would lead to a widening of the differences between interest rate levels across the regions, which has traditionally been a driver of currencies.

We haven’t been terribly surprised by the shift in interest rate expectations described above. And we’re not convinced it fundamentally alters the investment outlook. Our approach continues to lean on a few high-level views. First, higher bond yields have improved the return potential for bonds, providing us with a more useful tool for some of our client portfolios. Second, we believe equities face a range of outcomes over the next few years that is a bit wider than normal, stemming from the rapid series of interest rates hikes over the last few years. That said, it’s clear that the U.S. economy has demonstrated less sensitivity to interest rate increases than other regions thus far, supporting its equity market. Nevertheless, we are managing our asset allocation positioning more carefully than usual given the macroeconomic backdrop.

Thoughts from our Portfolio Advisory Group on global markets and key developments  

February 9, 2024 - We discuss the resilience and recent signs of strength for the U.S. economy

Expectations that central banks will lower interest rates in the coming months have moderated recently. Meanwhile, the global equity market is off to a reasonably good start this year, driven once again by the U.S. market and large-cap technology stocks. Notably, an abundance of recent data suggests the U.S. economy not only remains resilient but is showing signs of strengthening. We discuss this more below.

Through much of 2023, there was evidence of slowing growth globally, particularly in the manufacturing sector, and to a lesser extent services. In contrast, the U.S. appeared to be moderating rather than slowing to the degree seen elsewhere. As a result, investors’ confidence in central banks’ ability to effectively cool economic activity to ease inflationary pressures has been steadily rising over the past year.

Recent data continue to highlight the U.S. economy’s resilience. The latest jobs report revealed an addition of 353,000 jobs in the month of January, nearly double the anticipated amount. Moreover, figures for the prior two months were revised higher, and gains were spread across a variety of industries as opposed to a select few. While layoff announcements have attracted attention over the past year, the employment backdrop has yet to markedly deteriorate. The number of Americans filing for unemployment benefits remains stable, and relatively strong wage growth continues. However, as usual, there are some signs of moderation to keep in mind. These include: an increase in part-time workers and a decrease in full-time positions, a lower number of job openings, and fewer people quitting their jobs. But overall, the U.S. labour market continues to display impressive strength. 

Other recent indicators also signal a favourable backdrop for the U.S. For example, January’s manufacturing data, while still weak in absolute terms, was better than expected and reached its highest level in over a year. Furthermore, the “new orders” component was particularly strong and may suggest further gains ahead. The services sector also showed an acceleration in January, while other areas such as consumer confidence and construction spending also came in reasonably strong. Additionally, an improvement in financial conditions – often measured by a combination of equity market performance and the cost of accessing credit – is supportive for business activity overall.  

A lingering question is whether U.S. inflation can continue to moderate in the face of an economy that is potentially reaccelerating. This may take some time to answer. With inflation largely trending in the right direction, the economy resilient as ever, and the U.S. central bank contemplating rate cuts, the U.S. equity market may continue to push higher for the time being. So too could investor optimism, as it often does when things are going well. As always, it’s our responsibility to remain level-headed and attentive to the risks and opportunities that may emerge. 

 

Why asset allocation matters

Investors often get caught up focusing on what sector, fund, or stock could be the next “big thing”. But investors should not lose sight of one of the most important decisions that could impact their long-term investing outcome: their asset mix.

A constant source of debate for investors has been the outlook for global equity markets, the direction of interest rates, which sectors to overweight and underweight, and what funds and stocks may be the winners of tomorrow. Yet investors should step back from the day-to-day nuances of the markets to ensure they have the proper asset allocation for their long-term goals. 

Ultimately, asset allocation is often the primary driver of long-term portfolio risk and returns. This approach to portfolio construction may be particularly relevant after a prolonged period of outperformance in one asset or sub-asset class, when investors may question the need to have anything else in their portfolios. So we’d like to remind investors why appropriate asset allocation matters.

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