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CA-EN Institutional

BMO ETF Portfolio October Commentary: A Month of Two Stories

October 17, 2023
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Portfolio Activity

  • We moved the equity weight of the BMO Income ETF Portfolio and BMO Conservative ETF Portfolio further underweight equities during the month, in recognition of the additional volatility.
  • We have closed our U.S. Industrials position, completing a full rotation into U.S. Energy that we initiated during the summer. Continued expectations of constrained supply, and sustained demand despite concerns over any first quarter 2024 economic slowdown remains our base case.
  • We have been nibbling away at longer-term bonds, reducing our underweight duration position, with an eye to overweight.

A Month of Two Stories

September saw a sharp spike in interest rates following the U.S. Federal Reserve (the “Fed”) meeting, with 10-year yields on U.S. Treasuries reaching 4.57% by month end, the highest since July 2007. The combination of hawkish commentary, stickier core inflation, and higher energy prices all led to a bond sell-off across the curve. There are other factors than just changing Fed expectations, however, including the refinancing issuance of the U.S. Treasury, continued quantitative tightening, a growing U.S. budget deficit, and the inevitable exit of Japan’s yield curve controls that have all acted as an anchor to global rates. This has resulted in a return to positive stock and bond correlation, the boogeyman of 2022’s painful year for balanced portfolios. The outlook for inflation is much more benign now and markets pricing of rate cuts by next summer are also tempering these pressures. Even though there is the potential for further upward yield movement, we have begun to close the underweight of duration that we have held over the summer, slowly adding to longer bonds. While this may prove early upon future retrospection, the cost of being late in moving to an overweight position is higher, in our collective view.
The month was also significantly impacted by the threat of a U.S. government shutdown, narrowly avoided at the 11th hour, with a limited funding package that will kick the issue down the road to November 17. For those less familiar, a shutdown might seem to be a crisis event, but there’s actually been 20 partial or full shutdowns since 1976, averaging 8 days each, with the longest full shutdown being 16 days in 2013, while 2019’s partial shutdown was the longest at 35 days. Various services would be cut back (labour mediations, consumer and environmental investigations) or closed entirely (national parks and museums, civilian defence personnel on furlough, small business loans), but the most prominent market influence would be the delay of major economic data headed into the December Fed meeting. Information on spending, employment and inflation would all be delayed, leaving a blind spot in the runway for the Fed’s soft landing. Employment-wise, the shutdown could impact up to 900,000 of the 2.3 million government employees with unpaid leave. More broadly, the rough estimated drag on economic output is 0.1% – 0.2% per week of full shutdown, although much of this is typically reversed in subsequent quarters as essential workers are finally paid for the time they kept working, and even furloughed workers are partially reimbursed. There may be longer term implications though, Moody’s warned on September 25 that their AAA rating (the last one standing) could be cut based on demonstrated political dysfunction paired with wider deficits and higher servicing costs. The last of the three major ratings agencies to maintain the AAA rating, it would not be a huge surprise to markets if it were to fall but would impact any investors with weighted-average credit parameters/requirements around their portfolios.
Combined, the month saw a sell-off of global equities that has continued into the first week of October, with higher for longer becoming more ingrained in markets and central bank narrative. With still strong Consumer Price Index (CPI), consumer spending, and employment, further hikes are still well within reason, with rate cuts currently priced in no earlier than the third quarter of next year. In Canada, an October hike is widely expected, while the U.S. trajectory is flat into year-end.
Third quarter Earnings Per Share (EPS) estimates are now tracking roughly 9% lower than a year ago, with bounces in the Energy, Discretionary, Technology and Communications sectors since the summer trough, offset by continued deterioration of the expectations for the Industrials and Materials sectors. Upward revisions within the index are tracking at 51%. Valuation multiples have contracted from their recent highs, with the S&P 500 Index’s forward Price to Earnings (P/E) ratio at 19.6 versus 21.3 at the end of July. In the U.S., we have seen improvements in the ISM Manufacturing Purchasing Managers Index (PMI), although still in contraction with a reading of 49, up from 47.6 in August, while the ISM Services PMI remained strong at 54.5. This contrasts with Canada’s continued decline in the Manufacturing reading to 47.5 from 48 in August.

As we look to year-end, the short-term set up for a bounce in equity markets is in place, but we remain cautious of the yet-to-be-determined impact of the sharp surge in rates, and whether the Fed will feel the need for one more hike or if we have truly seen the end of rate increases.


The views expressed in this document are those of the Portfolio Manager. They do not necessarily represent the views of BMO Global Asset Management. The views and opinions have been arrived at by the Portfolio Manager and should not be considered to be a recommendation or solicitation to buy or sell any products that may be mentioned.

This material may contain forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may”, “should”, “expect”, “anticipate”, “outlook”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue reliance on such statements, as actual results could differ materially due to various risks and uncertainties.

This communication is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Particular investments and/or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance. BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from the Bank of Montreal.

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