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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