- Equity markets rose this week, alongside a debt ceiling deal and mixed run of economic data. The S&P 500 added 1.8%, with all sectors posting gains. Congress passed the Fiscal Responsibility Act, which will suspend the U.S. debt ceiling until January 2025 along with some discretionary spending cuts.
- While the acute near-term risk of a bad credit outcome relating to the debt ceiling is now dealt with, the much more chronic problem of the United States’ fiscal situation is going to persist.
- Meantime, U.S. payrolls surged by a stronger-than-expected 339k in May, but the details were weaker than the big headline. The jobless rate rose three ticks to 3.7%; hours worked dipped; and wage growth cooled to 4.3% y/y, although the 3-month annualized trend is still firm at 4.0%. Elsewhere, jobs openings rebounded to 10.1 million in April, but consumer confidence fell (May) and manufacturing remains in contraction, as measured by 46.9 on the ISM.
Is Technology current overpriced? It’s a reasonable question given that the majority of S&P 500 gains this year have come from the top five companies by market capitalization, all of which are tech-oriented. Our perspective is that while tech isn’t necessarily overpriced, that kind of concentration of returns is not indicative of a healthy market. Having such a great disparity between the top names and the rest of the market creates a misleading impression that markets are strong, when in reality it’s only the big companies that are doing particularly well. As we’ve discussed in this space previously, Quality is important, and those kinds of companies should benefit from higher multiples—that’s why I wouldn’t necessarily say that the Nvidias, Apples and Microsofts of the world are overvalued. Certainly, any company involved in artificial intelligence (AI) is benefitting from a spike in investor interest, in a fashion not dissimilar to the late 1990s, when anything internet-related took off like crazy. We know with the benefit of hindsight that the dot-com bubble eventually burst. But if you fast forward ten years, a lot of those key companies did live up to the hype, with firms like Google and Amazon becoming market leaders. In the case of AI, things may be moving up a little too much too fast. But if there are only a handful of Quality companies out there and investors are looking for safety in anticipation of an economic downturn, the valuations may be justified. On top of that, I don’t think the hype in AI is going away, but is just getting started. There’s also the possibility we could see a rotation at some point, which would give other companies a chance to catch up.
Bottom Line: The recent move up in the markets is not indicative of all companies doing well. Concentration of returns is a cautious sign for markets, but it doesn’t necessarily mean that Technology is overpriced.
The latest Consumer Price Index (CPI) numbers from the Eurozone showed inflation dipping significantly. This is unquestionably good news. But looking ahead, we would nonetheless advise caution, as we expect some of the recent positive economic surprises to become less positive. Over the past six months, Europe has benefitted from a milder-than-expected winter and lower energy prices. While it may continue to benefit from the latter, some familiar questions are likely to re-emerge as we enter the second half of the year, and Q4 in particular: Will it be a colder winter this year, causing Europe’s energy needs to spike? What will OPEC do about supply? How will Russia respond, both as an energy supplier and on the front lines in Ukraine? Not to mention the China re-opening has not been as strong as expected. For these reasons, we’ll continue to revisit our strategy with respect to Europe, and consider whether it’s time to go back to an underweight position.
Bottom Line: While recent inflation news is encouraging, we expect the European economy to remain stagnant through the end of 2023.
With the U.S. Federal Reserve signaling a pause on rate hikes at their next meeting but leaving the door open for more increases later in the year, what’s the status of the bond market? In general, we still like bonds from a price standpoint. Certainly, the possibility of further monetary tightening, both in the U.S. and Canada, adds some pressure. But with bonds up around 2-3% this year and GICs yielding 5%, if you extrapolate to the end of the year, bonds could still outperform GICs, which is what one would expect. The additional upside we see with bonds is that if markets do experience some difficulty, bonds could receive a lift because of the possibility of a rate cut, which isn’t the case with GICs. Even just the signal of a pause should be a positive for bonds because it means we’re getting closer to that much-anticipated monetary easing. The one thing that investors will want to be careful to avoid is getting into the lower-quality space. Given rate hike risks and the potential for an economic downturn, we recommend sticking with quality, same as in equities. We have been adding a little to duration, but not too much too fast; we’d like to hear more from the Fed before deciding where to go on the curve. And at present, we prefer bonds over cash.
Bottom Line: For now, it’s wise to maintain exposure to bonds, because they can serve as diversifiers and will generate an attractive yield.
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