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THIS WEEK WITH SADIQ

Readying for a Real Estate Rebound

May 23 to 26, 2023

THIS WEEK WITH SADIQ

Readying for a Real Estate Rebound

May 23 to 26, 2023

Commentary

Market Recap

  • Equity markets rose this week alongside a bounce in U.S. regional banks, and an early-week vote of confidence from President Biden that a deal will get done on the debt ceiling.
  • On the latter, we’ll breathe easier when we actually see it, and negotiations were reportedly struggling as of Friday.
  • The S&P 500 rose 1.6%, led by banks and technology. The TSX, however, dipped 0.3% as materials weighed.

Bankruptcies

Last week, the New York Times reported that 2023 is set to be the biggest year for bankruptcies in more than a decade.1 Does this spell doom for equities? The rise in bankruptcies can be attributed to a couple of factors. First, it’s tied to companies’ access to lending—high interest rates have made borrowing costs untenable, limiting firms’ expansion plans. Second, it’s indicative that consumers are possibly being more selective in their spending. This drop in demand means that companies are getting hit from both sides—their expenses are increasing as a result of the rising price of labour, while their revenue is slowing down as inflation-tied earnings fade. Overall, this dynamic isn’t unexpected, and it’s a sign a recession remains fairly likely. Investors will want to keep an eye out to see if other companies are hit; we don’t necessarily expect this double whammy to significantly impact the big, blue-chip names, but it could mean more layoffs in the small business community. That’s why we continue to prefer Quality companies, which can withstand these sorts of headwinds.

Bottom Line: The rise in bankruptcies could be a sign of the other shoe dropping for the economy.

Real Estate

In both Canada and the United States, the real estate market may be showing signs of bottoming out. The U.S. might get there first, especially given the possibility of a pause on rate hikes from the U.S. Federal Reserve. If a pause does happen, it’s likely that we’ll start to see activity in the housing market pick up soon thereafter, as rate cuts will be on everyone’s mind and lenders will be thinking of ways to entice customers back into the market in advance of those cuts. Our expectation, however, is that there won’t be a lot of liquidity in the market. Many homeowners aren’t interested in selling at the moment, in part because of low prices and in part because if they end up selling and buying another house, they’ll likely have to pay more in interest on their next mortgage. High rental costs are also a contributing factor. In Canada, immigration is likely to continue to boost demand. In late 2022, the housing affordability situation in Canada worsened, but was cushioned in Q4 by lower home prices. With interest rates unlikely to go up significantly from here, we could see banks willing to offer more attractive terms going forward, including variable rates and special offers.

Bottom Line: While the U.S. real estate market is primed for a rebound, Canadian housing prices are unlikely to bounce back immediately, which should improve affordability in the coming quarters.

U.S.-China Tension

The situation between the United States and China continues to evolve, with the banning of TikTok in Montana the latest development to contribute to rising tension between the two economic superpowers. But what does this mean for investors? Geopolitical risk is hard to price because it’s difficult to predict. As I discussed last week, we do expect more noise in the coming months as a U.S. presidential election year approaches. The possibility of a TikTok ban has been in the news for a while, and we’re not particularly worried about it; a bigger concern would be the de-listing of Chinese stocks, which could create a tit-for-tat situation and problems for U.S. companies in China, but that hasn’t happened yet. In our view, one of the reasons we haven’t seen more money flowing into China and Emerging Markets more broadly is nervousness around geopolitical risk, and the Russian invasion of Ukraine didn’t help. We remain optimistic about Chinese equities, but if inflows don’t materialize, markets won’t move higher. This wasn’t the primary reason that we recently reduced our allocation to China, but it does help to explain why assets haven’t moved the way we’d hoped. Some investors have said that China is no longer investable, but our view is that everything has its price—if you’re getting a steep enough discount, you have to consider the opportunity. China is one of the world’s largest economies and most populated countries, with pent-up consumer savings from the pandemic potentially set to boost demand. There will be ebbs and flows, but in our opinion, it’s an opportunity that’s too great to ignore. We just need to be a bit patient.

Bottom Line: The value is there in China—it’s just a matter of waiting until the market recognizes it.

Positioning

A detailed breakdown of our portfolio positioning is available in the latest BMO GAM House View Report, titled Are the Bears Ready to Hibernate? Additionally, we’re examining potential opportunities in Japan and evaluating whether we should continue to sell covered calls in a sideways moving market. We’re looking to find incremental value and don’t anticipate any major shifts in our bonds or equities positioning in the near future. At this point, with markets continuing to fluctuate, we don’t want to take on or take off too much risk. We expect that markets may gradually grind up higher, but there’s still room for them to come down a bit before that happens.

Disclosures:

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