THIS WEEK WITH SADIQ

An Unusual Week: Jackson Hole and Q3 Bank Earnings

September 5 to 8, 2023

THIS WEEK WITH SADIQ

An Unusual Week: Jackson Hole and Q3 Bank Earnings

September 5 to 8, 2023

Commentary

Market Recap

  • Equity markets enjoyed a winning week to turn the page to a new month. Supporting the broad-based gains were data pointing to a softer labour force and therefore, more reason for the Fed to stand pat.
  • The S&P/TSX led the weekly gains, supported by an 11% pop in tech stocks, bringing that sector’s year-to-date bounce up over 50%.
  • A more modest 4% rise in tech and energy also powered the S&P 500 to a 2.5% rise on the week, while consumer staples and utilities lost some ground in that index.

Jackson Hole

Unlike previous Jackson Hole meetings, the latest symposium was noteworthy in that there wasn’t much information divulged that is likely to move markets. What was made clear, however, is that inflation has come down to a level that’s more acceptable, but not to a level where the U.S. Federal Reserve (the Fed) can officially call it quits—they’re still willing to push interest rates higher if that’s what the data suggests. This gives markets slightly more clarity on the fact that in the Fed’s mind, the job is not fully done. Not only could we see more rate hikes, but its also likely that rates will need to stay higher for longer to allow the economy to start to moderate, and for previous increases to filter through. Now the question is how long markets will believe this. History shows that the market quickly forgets what the central banks say and move to their own thesis. But it is a reminder that investors shouldn’t expect rate cuts any time soon. In our view, the Fed doesn’t want an actual recession; rather, what they’re aiming for is a smooth landing, with the economy and job market weakening just enough to prevent inflation from flaring back up.

Bottom Line: The Jackson Hole meeting underscored that even if the Fed does pause at their next meeting, it doesn’t necessarily mean they’re done raising interest rates.

Banks

Canada’s Big Six banks have released their Q3 earnings reports, and what’s clear is that we’re seeing higher loan loss provisions across the board. This tells us that the consumer is weakening—higher interest rates are having an impact, and banks are preparing for more bankruptcies and delinquencies going forward. Overall, results were mixed, and the story is one of slower economic growth. That said, the long-term fundamentals for the big Canadian banks remain strong, with healthy balance sheets, good long-term vision, and attractive dividends. There’s still a cloud hanging over Financials, and investors should be aware of the nuances between the different banks, but our belief is that the biggest damage is mostly behind us. This is true for U.S. banks as well. Firms like Citigroup, Bank of America, and JPMorgan Chase are all trading low relative to the S&P 500, which hasn’t happened in some time. In the past 50 years, it has been very rare to see an extended stock market rally that excluded banking, so we expect a catch-up trade of some kind due to this valuation disconnect, but you do need to be patient. In general, we think it’s wise to view banking as a long-term trade and not try to be too tactical.

Bottom Line: It may not happen immediately, but in the longer term, we expect the big banks in Canada and the U.S. to outperform the broader market.

Oil

The big story in Energy is that demand for oil remains high while supply is still limited—that differential is what’s causing crude prices to stay elevated. The fact that recession risks keep getting pushed out and that inflation continues to linger over the 2% threshold have also been tailwinds. We believe that the current range of $80-$90 per barrel represents fair value, and that there’s room for Energy stocks to go higher. The question we’re asking ourselves is how we want to play it. Is it through broader exposure to the sector? Or with covered call strategies? Or do we add a layer of selling put spreads so that we can buy into Energy if there’s a pullback but get paid if it stays rangebound? We made a great call on Energy about a year and a half ago, opening and closing a position at opportune times. Now, we’re revisiting potential opportunities in the sector, and most likely, our exposure won’t be through a pure long position—if you can get paid a 3-5% premium selling a monthly option, that’s a good win even if the stock doesn’t do much.

Bottom Line: With oil prices buoyed by high demand, limited supply, and the overall economic environment, potential opportunities in Energy are worth examining.

Positioning

There’s no doubt that this market has been extremely resilient. Even though we saw a bit of a pullback in August, as we were expecting, we’re already seeing some of those declines reversing, and earnings have been good-to-great despite continuing negativity in Financials and Retail. In our view, this is not yet a situation where investors should be too cautious. There are ways to build some protection into a portfolio without getting overly conservative—for instance, rotating from Discretionary to Staples, adding duration as we approach the likely end of the rate-hiking cycle, or holding some gold. We expect that September will be a bit choppier for markets, which is certainly worth keeping in mind. But you don’t want to miss opportunities that might come along, like in August when the Nasdaq declined. A little bit of caution goes a long way, and that’s how we’re positioning ourselves at present.

 

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Prices Cool in a Scorching Summer: What Happens Next?

 

As Chief Investment Officer, Sadiq S. Adatia’s views directly influence the BMO ETF Portfolios.

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