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June 2023 Commentary

BMO ETF Portfolios June Commentary: Bearing The Weight

June 9, 2023

June 2023 Commentary

BMO ETF Portfolios June Commentary: Bearing The Weight

June 9, 2023

Commentary

Portfolio Activity

  • We reduced our exposure to China, as our concerns over slowing economic momentum and reduced investor flows have capped our enthusiasm for Chinese equities. Valuations have returned to their average level and increasing concerns over slower European economic activity will have a knock-on effect upon export demand.
  • We have also reduced our EAFE position back to underweight, adding to Canadian equities. Primarily capitalizing on the recent sell-off of both Energy and Banks, the relative strength of the Canadian economy versus Europe’s is also a consideration.
  • Within EAFE, we have tilted toward Japanese equities which remain one of the stronger regions year-to-date. With one half of listed equities trading below book value, Japanese equities make an attractive off-set to the growth-dominated S&P 500 Index.

Bearing the weight

May ended with the proverbial light at the end of the tunnel, as the U.S. Debt Ceiling drama neared its conclusion, with an ultimate agreement on a deal to raise the cap without review until January of 2025, after the next Presidential election.  The deal included changes to planned spending on IRS staffing, clawbacks of unspent COVID funding, and a fast-tracking of energy project permit approvals going forward.  The market reacted as expected, with a pop, amplifying the month’s gains in the final days.

Meanwhile, the Nasdaq continued its year-to-date climb, turning parabolic with the blowout earnings of NVIDIA, and parabolic projections of AI-related future earnings across other tech names.  This has led to an unprecedented differential between the contribution of the top 10 names in the S&P 500 Index and the other 490 stocks making up the index. A similar view of this is a comparison of the equal weighted index versus the more ubiquitous market-cap weighted version.  On its own, this phenomenon isn’t necessarily reason to flee to safer pastures, but it certainly adds to a queasy feeling from abnormally low volatility, sticky inflation and increasing odds of a U.S. recession.   And while no longer the lead story, the banking crisis of the first quarter remains a concern to those observing lending standards to smaller businesses by regional banks.

Following month end, U.S. non-farm payrolls delivered a significant upside surprise, with 339,000 new jobs versus a consensus expectation of 195,000, with upward revisions to prior months.  And yet, initial claims bumped up, average hourly earnings growth slowed modestly from 0.4% to 0.3%, and hours worked fell. The ISM Manufacturing Index fell from 47.1 to 46.9, while the non-Manufacturing index remained firmly in expansionary territory. Perhaps the most important measure, the U.S. Core PCE jumped 0.4% for April, as did the super-core measure, which strips out housing prices along with energy and food (so, if you live in your car and don’t drive it anywhere, including drive-through windows, you’re good…).

Here at home, the economy also continued at a brisk pace, with the April jobs reading coming in at 41,400 jobs, holding the unemployment rate at 5%.  Headline CPI ticked up to 0.7% month-over-month from the previous 0.5%, for a year over year 4.4%. These numbers, combined with a firming of house prices and activity have brought the prospects of a Bank of Canada (“BoC”) increase this summer.  Checking the S&P/TSX Index, the banks had a mixed quarter, with loan loss provisions eating into earnings, with 4 of the Big 5 missing analyst estimates.  Lower oil prices also weighed on the energy sector, leaving Canadian equities to broadly underperform their global peers.

Across the pond, inflation seems to have peaked but remains far too high.  In the UK, headline inflation fell to 8.7% year-over-year, but food soared 19% higher for the second month in a row.  The core rate was a bit better at 6.8%, but at a three-decade peak, the Bank of England has more work to do. The broader Eurozone saw headline price increases of 6.1% in May, with core of 5.3%.

All of this leaves the investors once again playing Pin the Tail on the Fed (U.S. Federal Reserve), and whether they will pause in June or the now preferred “skip” with an increase in July. Rates ticked higher on the prospect, and odds of rate cuts in 2023 have all but been priced out of the futures market, while the implied terminal rate expectation has risen to 5.45%

All in all, it’s hard to conclude that the outlook has become much clearer than a month ago, when the BMO Multi-Asset Solutions Team (MAST) house score moved to underweight. The AI rally certainly was a surprise, and we are always hesitant to chase such bursts higher. However, the conclusion of the debt ceiling issue removes a significant tail risk, but the mixed nature of economic and market data does not completely alleviate our concerns of the recessionary impact of falling earnings on equities.  The question is:  so how far out are we from said recession?  Pushing out the recession might suggest that the higher the market goes, the more room there is to fall, particularly for excessively valued growth stocks.  Yet it is hard to ignore the fact that earnings expectations have ticked higher for the remainder of 2023; jobs and consumer data have still not declined to warning levels, and the consensus bearishness does suggest the market is running out of sellers.  However, the market is not the economy, and the words “it’s different this time” may be dangerous, but then again, so are “totally impossible”. All this said, we are returning to neutral on our house equity call this month, but like the Fed, reserve the right to be “data dependent”.

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