An Economy at a Crossroads
As we emerge from a period of seasonality in which markets pulled back and investor nervousness shone through as expected, the focus now shifts to the gradual deterioration of the economy. So far, this is playing out as we anticipated—a slow, gradual decline with some potential upside surprises along the way. With interest rates remaining elevated, we’re also seeing another leg lower in the housing market; in fact, given the stubbornness of inflation, rate hikes remain a real possibility. “Higher for longer” is the slogan of the day, and the implied message is clear: don’t go overweight equities. But that doesn’t necessarily mean that you should be underweight equities, either.
Markets (Mis)Price in a No-Landing Scenario
BMO GAM House View
• Pockets of inflation persist, but it’s no longer broad
• There is still a risk of a second wave of inflation, in large part due to energy, but it is more manageable now than it was last year
• We may see another rate hike from the Fed, but the end of the cycle is near
• In Canada, it’s likely approaching and may already have arrived, though it should be mild
• The U.S. will have to wait a while longer
• The U.S. consumer is resilient
• The Canadian consumer is starting to struggle
• The market has survived the rate hiking cycle
• Now, the risk is layoffs, but that should be manageable
• The greatest risk is escalation of the Israel-Gaza conflict into broader Middle East war that disrupts oil markets
• Upside for oil is peaking as the demand side grows more negative.
• Risks are balancing, though, amid jump in geopolitical tensions
Long bond yields are stretching to levels we have not seen in quite some time. That doesn’t automatically mean equity valuations have to suffer, but we are still aware of short-term volatility and maintain defensive hedges within our overall positioning.
We have gone from a Goldilocks market, where the data flow was just good enough to maintain rising valuations, to one where too much good news has the market fearful of a prolonged bout of elevated rates—and the impact that could have on stocks.
Style & Factor
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