Equity markets struggled this week as a tough U.S. inflation print further dialed back rate-cut expectations.
The S&P 500 fell 1.6%, with financials, health care and materials posting the deepest declines. A mixed bag of early bank earnings also weighed late in the week.
Meantime, the TSX gave back 1.6%, as health care was trounced more than 12%, while higher-yielding names struggled.
Inflation
Last week, U.S. inflation numbers for March came in hotter than expected, prompting yields to rise and markets to reevaluate their rate cut expectations. The data highlights that the last leg of the inflation fight—from the 3% range to the 2% range—is going to be difficult, and may not come down in a straight line (as evidenced recently). We don’t think there’s a risk of inflation flaring back up to 2022 levels. The problem instead is that the U.S. Federal Reserve (Fed) and other central banks have specific inflation targets, and they may not feel comfortable cutting interest rates until they’re certain there’s enough momentum to get to the 2% range. January and February weren’t great months in this regard, and the March numbers were a continuation of that trend, likely pushing rate cuts further down the road. Markets now appear to be getting the message: at the start of the year, they were assuming six rate cuts; then it was three, but markets didn’t move because they still felt cuts were going to occur in 2024 and were just delayed; now, the most likely scenario is only one or two rate cuts in 2024, and we wouldn’t be surprised if there were zero. What happened with yields was a delayed reaction—markets are resetting because they finally believe the Fed’s “higher for longer” messaging. It was almost a reversal of the drop in yields that we saw in November when the Fed indicated that a pause was imminent. While some may be questioning whether Fed Chairman Jerome Powell can still guide the economy to a soft landing, we don’t think markets have lost confidence in the Fed at all. In fact, with the benefit of hindsight, Powell was right—CPI didn’t come down as much as everyone had expected. Now, the Fed will have to determine whether they’ll need to see 2% inflation in the next couple of months in order to cut rates, or whether they’ll be happy reaching 2% over the course of several months or the next year, which would allow cuts to come sooner.
Bottom Line: We continue to expect at least one rate cut from the Fed this year—the question is whether it will come in the summer, the fall, or as late as December.
Earnings
Earnings season is around the corner, and it’s reasonable to wonder whether the rate cut trajectory will affect how companies provide guidance. In our view, the interest rate situation likely won’t be a significant talking point, but the state of the consumer could be. In particular, we’ll be paying close attention to Consumer Discretionary and Consumer Staples—if companies like Walmart indicate that they’re seeing a rotation within their own stores from higher-value items to lower-value items, that could be proof that consumer spending habits are changing. More broadly, portfolio managers and analysts from our Global and Fundamental Equity teams will be monitoring earnings announcement with a focus on three areas: geopolitical risks, inflation, and the consumer. They’ll convey those insights to the broader investment team to make sure everyone is attuned to the latest developments, just as they do after their frequent trips to conferences and meeting with corporate leaders.
Bottom Line: We believe consumer spending patterns are changing—that’s why we’ve shifted to neutral on Consumer Discretionary vs. Consumer Staples from our previous tilt toward Discretionary.
Oil
We’ve believed for a while that $80-$90 per barrel was the right price range for oil, and that’s exactly where it’s been trading for the past several weeks. Given geopolitical risks, it’s possible that it could cross the $90 mark. But for now, we’ve moved back down to neutral on Energy because we’ve already had a good run-up and we’re happy with our gains. While we haven’t eliminated our position entirely, we don’t necessarily want to threw new money at it, and we’ve sold some call options on the sector in order to crystallize our profits. Looking ahead, we believe the supply-demand balance in the oil market is appropriate: the economy is not likely to experience a hard landing, so demand should stay up, and OPEC should feel comfortable enough in the $80-$90 range that they won’t need to unlock additional reserves.
Bottom Line: Given supply and demand dynamics, we believe that oil prices are currently within an appropriate range, so a neutral stance makes sense.
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.
For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.
®/™Registered trademarks/trademark of Bank of Montreal, used under licence.
The view from 10,000 feet is that the economy is still in fairly good shape. That said, it is important to understand that we are beginning to see more signs of underlying economic weakness.
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Jerome Powell Was Right
April 15 to 19, 2024
Jerome Powell Was Right
April 15 to 19, 2024
Sadiq S. Adatia, CFA, FSA, FCIA
Market Recap
Inflation
Last week, U.S. inflation numbers for March came in hotter than expected, prompting yields to rise and markets to reevaluate their rate cut expectations. The data highlights that the last leg of the inflation fight—from the 3% range to the 2% range—is going to be difficult, and may not come down in a straight line (as evidenced recently). We don’t think there’s a risk of inflation flaring back up to 2022 levels. The problem instead is that the U.S. Federal Reserve (Fed) and other central banks have specific inflation targets, and they may not feel comfortable cutting interest rates until they’re certain there’s enough momentum to get to the 2% range. January and February weren’t great months in this regard, and the March numbers were a continuation of that trend, likely pushing rate cuts further down the road. Markets now appear to be getting the message: at the start of the year, they were assuming six rate cuts; then it was three, but markets didn’t move because they still felt cuts were going to occur in 2024 and were just delayed; now, the most likely scenario is only one or two rate cuts in 2024, and we wouldn’t be surprised if there were zero. What happened with yields was a delayed reaction—markets are resetting because they finally believe the Fed’s “higher for longer” messaging. It was almost a reversal of the drop in yields that we saw in November when the Fed indicated that a pause was imminent. While some may be questioning whether Fed Chairman Jerome Powell can still guide the economy to a soft landing, we don’t think markets have lost confidence in the Fed at all. In fact, with the benefit of hindsight, Powell was right—CPI didn’t come down as much as everyone had expected. Now, the Fed will have to determine whether they’ll need to see 2% inflation in the next couple of months in order to cut rates, or whether they’ll be happy reaching 2% over the course of several months or the next year, which would allow cuts to come sooner.
Bottom Line: We continue to expect at least one rate cut from the Fed this year—the question is whether it will come in the summer, the fall, or as late as December.
Earnings
Earnings season is around the corner, and it’s reasonable to wonder whether the rate cut trajectory will affect how companies provide guidance. In our view, the interest rate situation likely won’t be a significant talking point, but the state of the consumer could be. In particular, we’ll be paying close attention to Consumer Discretionary and Consumer Staples—if companies like Walmart indicate that they’re seeing a rotation within their own stores from higher-value items to lower-value items, that could be proof that consumer spending habits are changing. More broadly, portfolio managers and analysts from our Global and Fundamental Equity teams will be monitoring earnings announcement with a focus on three areas: geopolitical risks, inflation, and the consumer. They’ll convey those insights to the broader investment team to make sure everyone is attuned to the latest developments, just as they do after their frequent trips to conferences and meeting with corporate leaders.
Bottom Line: We believe consumer spending patterns are changing—that’s why we’ve shifted to neutral on Consumer Discretionary vs. Consumer Staples from our previous tilt toward Discretionary.
Oil
We’ve believed for a while that $80-$90 per barrel was the right price range for oil, and that’s exactly where it’s been trading for the past several weeks. Given geopolitical risks, it’s possible that it could cross the $90 mark. But for now, we’ve moved back down to neutral on Energy because we’ve already had a good run-up and we’re happy with our gains. While we haven’t eliminated our position entirely, we don’t necessarily want to threw new money at it, and we’ve sold some call options on the sector in order to crystallize our profits. Looking ahead, we believe the supply-demand balance in the oil market is appropriate: the economy is not likely to experience a hard landing, so demand should stay up, and OPEC should feel comfortable enough in the $80-$90 range that they won’t need to unlock additional reserves.
Bottom Line: Given supply and demand dynamics, we believe that oil prices are currently within an appropriate range, so a neutral stance makes sense.
Positioning
For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Delayed Again: The Soft Landing that Never Comes.
Disclosures:
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.
For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.
®/™Registered trademarks/trademark of Bank of Montreal, used under licence.
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