- We are looking to capitalize on the tech focus of the recent rally and the stark difference between valuations of the average stock in the S&P 500 Index and the biggest tech names in the index. We have thus initiated a position in an equal-weighted S&P500 ETF, which reduces the focus on the tech sector, providing exposure to a benchmark that is trading at a reasonable 16.9 forward price-to-earnings multiple, versus the 20.4 of the basic S&P 500 Index, and the pricey 30.6 of the Information Technology sector.
- We also see value in the Canadian banks and following month-end made an allocation to BMO Equal Weight Canadian Banks ETF. Attractive dividend yield, and secure capital ratios are hallmarks, and when trading at the current price/book ratios well below the long-term average, we see this as a medium-term position that will benefit the portfolios in the year ahead.
- We continue to like U.S. Industrials on a tactical basis. Participation within the sector has been among the broadest, and upgrades in global GDP forecasts, coupled with a reversal of the current Services over Durable Goods preference in consumer spending in a soft-landing scenario, should support continued gains. Eventual cuts by the Fed will also push the U.S. Dollar lower, an additional tailwind for U.S. industrial exports.
- Although being underweight equities has cost us some relative performance, we have made up a fair bit of it through other allocations across our 5 Lenses, including our tilt to Japanese equities, overweight of investment grade corporate bonds, and underweight of European equities.
If you grew up in Canada, or are a fan of Mike Myers, you probably are familiar with the exclamation. It is the ubiquitous signal that impending danger has passed, and that prior activities can continue once more, until interrupted by the next approaching threat.
In June, not only did the proverbial car pass global markets without incident, but equities also behaved as if the entire neighbourhood had been closed off for the annual tournament. With a pause from the U.S. Federal Reserve Board (the “Fed”) and continued momentum among technology stocks, equities continued to price recession concerns further into the future. The shift from rate cuts back to additional rate increases were priced into the market, with the Bank of Canada moving again, as did the European Central Bank, with Jerome Powell making it clear that the July Fed meeting remained “live”, a hawkish intonation to the broadly expected hold placed on rate increases at the June 14th meeting.
The continued push higher in yields further inverted yield curves, which first inverted 11 months ago. This traditionally has been the bell to start the countdown to recession, but it is ringing hollow this time. First quarter U.S. GDP was revised to 2.0% versus 1.4%, while the easing personal consumption expenditure (PCE) helped egg on investors. U.S. headline inflation continued to cool, from 5% year-over-year in March to May’s 4% reading. This was partially on base effects, but also from recent drops in oil prices. Core inflation however remained virtually unchanged on a year-over-year basis, moving only 30 basis points lower to May’s 5.3% figure. Canada made better progress on the inflation front, with May’s headline and core CPI readings falling to 3.4% and 4.0%, respectively.
One of the concerns regarding the current rally has been how narrow breadth and participation has been, both at the sector and individual stock level. Artificial Intelligence (AI) related valuations have become extreme by any measure, and when compounded with the dominant weights of key names like Microsoft, NVIDIA, and Alphabet, it certainly places a lot of chips in one corner of the table. However, it also reflects a view that investors are now looking beyond the short-term of the next 12-24 months, and even any potential recession. While the first is definitely a good thing, the second seems to be a little dismissive of the potential negative impacts of even an average recession.
A couple of things itch at the back of one’s mind though. Oil seems to be stuck in a range well below what is expected of a global economy moving back to trend growth. Employment-leading indicators continue to creep up, although issues of fraud in some states provides a large grain of salt to help digest negative data in the short-term. Housing costs have certainly not come anywhere near returning to pre-COVID levels, with Canadian prices already turning back to positive gains despite high mortgage rates. The U.S. market is less interest rate sensitive, but rents continue to climb in major urban centres.
While being a bear during a rally is never fun, jumping on a narrow rally with a less than clear economic and earnings outlook is even less appealing to us.
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