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THIS WEEK WITH SADIQ

Will Bonds Ever Take Flight?

March 4 to 8, 2024

THIS WEEK WITH SADIQ

Will Bonds Ever Take Flight?

March 4 to 8, 2024

Commentary

Market Recap

  • Equity markets notched further gains this week amid a mixed run of growth and inflation data.
  • The S&P 500 rose 0.9%, led by technology and consumer discretionary.
  • The TSX added 0.7%, with energy getting a boost from a return to $80 oil. Bank earnings results were mixed, and the sector finished the week little changed when all was said and done.

Fixed Income

In the first two months of the year, we have not seen as strong of a rally in fixed income as we saw at the end of 2023. What’s behind this disappointment? The key here is that late-2023 performance was driven by the U.S. Federal Reserve’s (Fed) November pivot and the expectation that interest rate cuts would come relatively quickly; initially, markets priced them in for around March. Now, continuing strength of the U.S. economy has pushed those cuts back to June or even later. As a result, bonds’ momentum has slowed. The good news, in our view, is that the underlying thesis is still correct—as long as you believe rate cuts are coming, you can still be bullish on fixed income. When cuts do occur, they aren’t likely to be one-and-done or two-and-done; it’s a process that could play out over a few years, with the easing cycle spread out more than many were expecting. That means we could see many good years for bonds relative to cash and GICs, as rates for cash-like instruments will have to come down when cuts begin.

Bottom Line: With fixed income, patience is a virtue—the moment rate cuts appear imminent and investor sentiment changes, we could see a big lift-off.

Earnings

The latest round of earnings announcements is mostly over, and investors were generally happy with what came through. The big positive was Nvidia beating expectations again, as I discussed in this space last week—that has kept markets higher than expected. You can expect some profit-taking in areas that have moved up, including companies like Nvidia at some point. But at the same time, areas like Bitcoin and crypto have caught momentum and are keeping investors tied to the market, so we wouldn’t expect any kind of massive sell-off anytime soon. We still expect more volatility this year than last year, but overall, the news for U.S. equity markets is mostly positive. In Canada, as expected, banks have experienced some headwinds from their non-performing loans, but their dividends continue to look secure. We take a long-term view of Financials—quality is important, and Canadian banks tend to be high-quality, whereas in the U.S. there is a differential between the larger, higher-quality banks and the smaller, regional banks. In our view, any dips in quality bank stocks (in Canada and globally) represent potential buying opportunities.

Bottom Line: U.S. earnings were generally positive, while in Canada, we view the banks as a long-term opportunity despite near-term headwinds.

Magnificent Seven

Since last year, U.S. equity markets have been dominated by the Magnificent Seven: Microsoft, Apple, Nvidia, Amazon, Alphabet (Google), Tesla, and Meta (Facebook). Can investors still expect to see some catch-up from names outside that group? In short, yes—we still expect good results coming from the majority of the Magnificent Seven, but as the year progresses and investors begin to examine valuations a bit more closely, a rotation to other names is likely. While Nvidia’s recent earnings announcement captured plenty of headlines, other companies also did pretty well—we saw good numbers from Walmart, for example. Another way we’re seeing money rebalancing is via options. With stock prices for the leading names so high, some investors are buying call options on the Magnificent Seven rather than buying actual shares, while going long other (non-Magnificent Seven) stocks.

Bottom Line: We’re likely to see a modest rotation to names outside the Magnificent 7 as the year progresses and the rally broadens out.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled The American Exception: How U.S. Markets Beat the Bears…Again.

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