Know When to Hold ’Em
When is it the right time to bet big? That’s the big question this month, both in markets and at the annual World Series of Poker, taking place in Las Vegas throughout the months of June and July. Poker players know that before you go all-in, it’s crucial to have as much information as possible. It’s no different for investors.
This month, after much consideration, we upped our Equity allocation from underweight (-1) to neutral (0). There were three themes that influenced our thinking. First, a potential recession continues to be pushed further and further out, with a relatively soft landing sometime in 2024 still the most likely scenario in our view. That means that in the near term, the economy can be expected to grind lower, but at a pace that is still sufficient for consumers to feel alright and continue to spend. Second, job losses are occurring, but not at a magnitude that is worrisome, and there are still many job openings to facilitate those who are laid off. And third, as we take stock of markets, we can’t ignore last year’s massive downturn. It has led to more attractive valuations, and we believe there’s room for markets to grow—especially in nontech names, since they haven’t participated as much in markets’ performance year to date, which has been driven almost entirely by the top six or seven mega cap names.
For now, we don’t have enough data to say that markets will take off strongly from here, and we don’t have enough data to say that markets could crash imminently. When information is that limited, you simply don’t want to be making massive bets, hence our shift to a neutral position on Equities. We do believe that inflation is going to remain stubbornly sticky in the near term. The Bank of Canada’s (BoC) interest rate increase in June highlights the fact that even if the U.S. Federal Reserve (Fed) decides to pause, it won’t necessarily mean the end of the rate-hiking cycle—rather, a pause is merely a pitstop as central banks wait until they can act confidently one way or the other. It’s not so different for investors. For now, a cautiously optimistic view is warranted, as we wait and see what the economic data tells us about which direction markets may move.
North American Economies Remain Resilient
The Fed and Bank of Canada eye further interest rate increases as China stalls and Japanese equities rebound.
Another month, another solid jobs report. May’s payroll numbers strongly surprised on the upside, with 339,000 jobs being added. That underscores the resilience of the U.S. economy. The unemployment rate moved higher, but in our view, this reflects the fact that employment in the household survey tends to be noisier. We place more weight on payroll growth, and that along with Q2 real gross domestic product (GDP) tracking near 2% and jobless claims remaining low suggests that a recession is still at least a quarter or two away.
For emerging markets (EM), Chinese growth momentum remains lacklustre amid structural challenges, a weak property sector, weak foreign demand, and very cautious consumers. But one positive development in the past month is talk of stimulus targeting the Real Estate sector. This, along with steps to boost housing demand, should help to restore investor confidence. But the question is—will it be enough? Additional Chinese stimulus is key to our still-positive view on EM, but if there is further disappointment, we’ll be quick to reassess.
BMO GAM House View
Headline inflation is trending in the right direction
Core inflation will remain sticky
We appear to be near the end of a long and brutal hiking cycle in North America
The bar is set very high for a negative interest rate surprise over the next few months
You cannot have a recession without job pain
Canada and the U.S. are still creating jobs at a high pace, meaning a recession may be several months off
The labour market remains tight
U.S.-China relations can be expected to remain strained
We’re monitoring a potential executive order that could restrict U.S. investment in parts of the Chinese economy
Liquidity is on our radar as the Treasury General Account (TGA) is rebuilt
The lack of clarity on who will run in the 2024 presidential election creates uncertainty
Wage growth is now outpacing inflation
If we don’t see job losses, the consumer will be fine
This recession is likely to be triggered by the business side rather than being consumer-driven like it was in 2008
The market is bottoming out earlier than expected
In Canada, there is still a huge imbalance between supply and demand
Housing is likely to shift from a headwind to a tailwind as we head into 2024
Likely to remain a source of concern for markets
Smaller, regional banks tend to be more exposed around the recessionary cycle
This market rally reminds me of the old joke about getting chased by a bear while on a hike: you don’t have to outrun the bear; you just have to outrun the guy next to you. We’ve been slightly underweight (-1) Equities throughout the first part of this year, but with Technology really taking off due to the recent artificial intelligence (AI) mania, it’s led to a very narrow market rally. There are differing opinions as to whether narrowness is a good or bad sign for a durable rally. But it has certainly made it more difficult to decide whether to take a longer-term view, especially with an impending recession, or to re-evaluate our medium term outlook to participate in the melt-up currently occurring. To cut to the chase: we’ve moved our rating back to neutral (0) on Equities, from slightly bearish (-1). The fact that it’s only 10 or fewer names leading the charge is concerning, but it’s not unheard of considering those 10 names reside in the largest sector of the S&P 500. In Canada, banks are trading about 20% off their historical value after a series of disappointing Q1 results, while Energy stocks are also yielding value. Those sectors, in combination with the performance of U.S. Technology stocks, are why we’ve gone back to neutral.
In fixed income, the Fed is increasingly expected to “un-pause” its hiking cycle—even before the widely anticipated pause has officially occurred. The BoC has already resumed hiking, with an additional move possible in July as well. It certainly has made us reconsider our long-duration exposures. But since we’ve moved Equities back to neutral and are adding to that side of our portfolios, having duration as a counterbalance isn’t the worst thing in the world, either. In terms of our cash position, we’ve been moving out onto the short end of the curve—we’re seeing good yields in short term bonds, so we’d rather be there.
Mega-cap growth stocks have dominated the market in Q2, though high expectations are once again getting priced in. Regionally, the U.S. is looking far sturdier than it was, while Europe is further down the road to recession.
Style & Factor
Growth has had an impressive rally, but given the steep jump
in valuations, we’re looking to other parts of the market to play
catch-up. In particular, Value looks attractive, and to that end,
we’re moving to overweight on Japan’s value-oriented stocks.
The question is—can growth stocks continue to appreciate? Yes. Can they continue to outpace the S&P 500 index to the same degree? We would suggest no. That sentiment ties into the rationale for increasing our Equity allocation back to neutral: the rest of the market needs to play catch-up now. Our view is that we will see that performance gap narrow—we’re starting to see an uptick in participation in the rally from other sectors. Looking at metrics like how many names are trading above their 50-day moving average, those numbers are starting to tick up. That’s good—a broader market is always a healthier market.
We remain slightly bullish on gold as the US Dollar (USD) stands poised as a likely safe haven asset if markets tumble.
We continue to like gold and hold it across all our portfolios. It’s moved back below the $2000-per-ounce mark, which contributes to our slightly bullish (+1) assessment, and we’d be likely to buy it on the dips.
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
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