THIS WEEK WITH SADIQ

Inflation Cools as Equities Heat Up

July 24 to 28, 2023

THIS WEEK WITH SADIQ

Inflation Cools as Equities Heat Up

July 24 to 28, 2023

Commentary

Market Recap

  • Equity markets were mixed this week, patiently waiting for the results of next week’s FOMC meeting.
  • The S&P 500 rose 0.7%, while the TSX added 1.4%. The Q2 earnings season is underway, and it comes amid a still-tricky environment for profit growth and market expectations.
  • This week highlighted as much, with a number of banks topping estimates and suggesting higher rates are helping net interest margins; some big names like Tesla and Netflix reported good results but were sold by investors; some disappointing numbers in the chip sector weighed on tech; and for every consumer business touting sturdy demand, there was seemingly one (e.g., Best Buy) eying ‘recessionary behaviours.

Bonds

Inflation numbers continue to move in all the right directions, which is a positive sign for the bond market. The global cooling of rising prices gives central banks cover to slow down and potentially take a less aggressive stance moving forward. Banks in regions where inflation has calmed to reasonable levels may be able to stop raising interest rates altogether, while those in areas that still need to bring inflation down a bit will likely be able to shift from bigger increases (50 bps-plus) to smaller increments. This, in turn, will make the bond market more attractive and alternatives to bonds less attractive—bond gains are likely to rise while GIC rates will likely come down. It won’t happen right away, of course, but overall, it’s good news for bonds. For now, we’re taking a quality-oriented, diversified approach to fixed income, though that has relatively little to do with inflation coming down—it’s more tied to the economic weakness we’re likely to start seeing at some point.

Bottom Line: Cooling inflation is good news for investors concerned about rates rising further, though fears of rates staying higher for longer may continue.

Equities

On the equities side, markets have surged significantly in recent months and are now only about 5% off their all-time highs. Can this streak continue? In a word, yes—we think markets could reach record-breaking levels in the next couple of months. The question is whether they will steadily chug higher or if there will be some hiccups along the way; we expect the latter. We’re always a little wary of the months of September and October for markets, but there is still a whole month of potential gains before we get there. Last week, Tesla and Netflix announced earnings numbers that, while not necessarily bad in isolation, disappointed relative to expectations, causing their stocks to come down. That might be what we see this month—investors selling on news announcements after massive run-ups. Historically, there’s often been a bit of profit-taking after stocks have moved up dramatically. That’s not necessarily a bad thing, because it gives the market a chance to digest recent developments. Simply put, it’s hard to meet lofty expectations. No matter how great a company is, investors will start to question higher valuations, as we’ve seen recently with Nvidia. We’re aware of rising corporate bankruptcies but are not particularly concerned at this time. The more pressing issue is the likelihood of a shallow recession—we still expect the economy to weaken, and there are already some underlying signs, though they haven’t yet hit broadly enough to trigger a real downturn.

Bottom Line: Between now and the end of the year, markets are likely to move higher, but it could be a bumpy ride.

Hollywood

Tinseltown is at a standstill, as for the first time since 1960, both the Hollywood writers’ union (WGA) and the actors’ union (SAG-AFTRA) are on strike. There’s no doubt this will have an impact on streaming companies like Disney and Netflix—content is not going to be delivered, and it’s content that subscribers are paying for. That being said, the effects are likely to be mixed: in the near term, companies will continue to roll out already-produced content but see a decrease in expenses because new content isn’t being produced, while in the longer term, consumers could potentially cancel their subscriptions if they run out of things to watch, causing a drop in revenue. It’s possible that we’ll begin to see reports indicating that users are spending fewer hours on the platform, but this isn’t necessarily an indication of a poor outlook. View time isn’t the relevant metric—subscriptions are. To be blunt, it doesn’t matter if people are watching or not as long as they’re still paying their monthly fee. In our view, it’s unlikely that consumers’ behaviours will change in a meaningful way. Think of it this way: if there’s nothing worth watching, you may go do something else with your time, but you’re not going to throw away your TV. Only if subscriptions decline meaningfully should investors get worried, and we’re optimistic that consumers will prefer to simply wait for new content to emerge after the strikes are resolved.

Bottom Line: The Hollywood strikes will have an impact on streaming companies, but the temporary lack of new content is not likely to change people’s long-term behaviours.

Positioning

With a strong possibility that markets could move even higher, it’s not the time for us to take our foot off the pedal. Down the road, signs of a recession may emerge more forcefully, but for now, we don’t see a compelling reason to shift to an overly defensive position.
For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Staying the Course Through Choppy Waters.

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