Equity markets rose this week, alongside a debt ceiling deal and mixed run of economic data. The S&P 500 added 1.8%, with all sectors posting gains. Congress passed the Fiscal Responsibility Act, which will suspend the U.S. debt ceiling until January 2025 along with some discretionary spending cuts.
While the acute near-term risk of a bad credit outcome relating to the debt ceiling is now dealt with, the much more chronic problem of the United States’ fiscal situation is going to persist.
Meantime, U.S. payrolls surged by a stronger-than-expected 339k in May, but the details were weaker than the big headline. The jobless rate rose three ticks to 3.7%; hours worked dipped; and wage growth cooled to 4.3% y/y, although the 3-month annualized trend is still firm at 4.0%. Elsewhere, jobs openings rebounded to 10.1 million in April, but consumer confidence fell (May) and manufacturing remains in contraction, as measured by 46.9 on the ISM.
Interest Rates
Is Technology current overpriced? It’s a reasonable question given that the majority of S&P 500 gains this year have come from the top five companies by market capitalization, all of which are tech-oriented. Our perspective is that while tech isn’t necessarily overpriced, that kind of concentration of returns is not indicative of a healthy market. Having such a great disparity between the top names and the rest of the market creates a misleading impression that markets are strong, when in reality it’s only the big companies that are doing particularly well. As we’ve discussed in this space previously, Quality is important, and those kinds of companies should benefit from higher multiples—that’s why I wouldn’t necessarily say that the Nvidias, Apples and Microsofts of the world are overvalued. Certainly, any company involved in artificial intelligence (AI) is benefitting from a spike in investor interest, in a fashion not dissimilar to the late 1990s, when anything internet-related took off like crazy. We know with the benefit of hindsight that the dot-com bubble eventually burst. But if you fast forward ten years, a lot of those key companies did live up to the hype, with firms like Google and Amazon becoming market leaders. In the case of AI, things may be moving up a little too much too fast. But if there are only a handful of Quality companies out there and investors are looking for safety in anticipation of an economic downturn, the valuations may be justified. On top of that, I don’t think the hype in AI is going away, but is just getting started. There’s also the possibility we could see a rotation at some point, which would give other companies a chance to catch up.
Bottom Line: The recent move up in the markets is not indicative of all companies doing well. Concentration of returns is a cautious sign for markets, but it doesn’t necessarily mean that Technology is overpriced.
Europe
The latest Consumer Price Index (CPI) numbers from the Eurozone showed inflation dipping significantly. This is unquestionably good news. But looking ahead, we would nonetheless advise caution, as we expect some of the recent positive economic surprises to become less positive. Over the past six months, Europe has benefitted from a milder-than-expected winter and lower energy prices. While it may continue to benefit from the latter, some familiar questions are likely to re-emerge as we enter the second half of the year, and Q4 in particular: Will it be a colder winter this year, causing Europe’s energy needs to spike? What will OPEC do about supply? How will Russia respond, both as an energy supplier and on the front lines in Ukraine? Not to mention the China re-opening has not been as strong as expected. For these reasons, we’ll continue to revisit our strategy with respect to Europe, and consider whether it’s time to go back to an underweight position.
Bottom Line: While recent inflation news is encouraging, we expect the European economy to remain stagnant through the end of 2023.
Bonds
With the U.S. Federal Reserve signaling a pause on rate hikes at their next meeting but leaving the door open for more increases later in the year, what’s the status of the bond market? In general, we still like bonds from a price standpoint. Certainly, the possibility of further monetary tightening, both in the U.S. and Canada, adds some pressure. But with bonds up around 2-3% this year and GICs yielding 5%, if you extrapolate to the end of the year, bonds could still outperform GICs, which is what one would expect. The additional upside we see with bonds is that if markets do experience some difficulty, bonds could receive a lift because of the possibility of a rate cut, which isn’t the case with GICs. Even just the signal of a pause should be a positive for bonds because it means we’re getting closer to that much-anticipated monetary easing. The one thing that investors will want to be careful to avoid is getting into the lower-quality space. Given rate hike risks and the potential for an economic downturn, we recommend sticking with quality, same as in equities. We have been adding a little to duration, but not too much too fast; we’d like to hear more from the Fed before deciding where to go on the curve. And at present, we prefer bonds over cash.
Bottom Line: For now, it’s wise to maintain exposure to bonds, because they can serve as diversifiers and will generate an attractive yield.
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?
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.
Given recent inflation numbers, are markets resetting rate cut expectations, and is a soft landing is still possible? How will the state of the consumer impact earnings season?
What do Fed Chairman Jerome Powell’s recent comments mean for the interest rate outlook? And what impact are they having on equity and fixed income markets?
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Is AI the New Dot-Com Bubble?
June 5 to 9, 2023
Is AI the New Dot-Com Bubble?
June 5 to 9, 2023
Sadiq S. Adatia, CFA, FSA, FCIA
Market Recap
Interest Rates
Is Technology current overpriced? It’s a reasonable question given that the majority of S&P 500 gains this year have come from the top five companies by market capitalization, all of which are tech-oriented. Our perspective is that while tech isn’t necessarily overpriced, that kind of concentration of returns is not indicative of a healthy market. Having such a great disparity between the top names and the rest of the market creates a misleading impression that markets are strong, when in reality it’s only the big companies that are doing particularly well. As we’ve discussed in this space previously, Quality is important, and those kinds of companies should benefit from higher multiples—that’s why I wouldn’t necessarily say that the Nvidias, Apples and Microsofts of the world are overvalued. Certainly, any company involved in artificial intelligence (AI) is benefitting from a spike in investor interest, in a fashion not dissimilar to the late 1990s, when anything internet-related took off like crazy. We know with the benefit of hindsight that the dot-com bubble eventually burst. But if you fast forward ten years, a lot of those key companies did live up to the hype, with firms like Google and Amazon becoming market leaders. In the case of AI, things may be moving up a little too much too fast. But if there are only a handful of Quality companies out there and investors are looking for safety in anticipation of an economic downturn, the valuations may be justified. On top of that, I don’t think the hype in AI is going away, but is just getting started. There’s also the possibility we could see a rotation at some point, which would give other companies a chance to catch up.
Bottom Line: The recent move up in the markets is not indicative of all companies doing well. Concentration of returns is a cautious sign for markets, but it doesn’t necessarily mean that Technology is overpriced.
Europe
The latest Consumer Price Index (CPI) numbers from the Eurozone showed inflation dipping significantly. This is unquestionably good news. But looking ahead, we would nonetheless advise caution, as we expect some of the recent positive economic surprises to become less positive. Over the past six months, Europe has benefitted from a milder-than-expected winter and lower energy prices. While it may continue to benefit from the latter, some familiar questions are likely to re-emerge as we enter the second half of the year, and Q4 in particular: Will it be a colder winter this year, causing Europe’s energy needs to spike? What will OPEC do about supply? How will Russia respond, both as an energy supplier and on the front lines in Ukraine? Not to mention the China re-opening has not been as strong as expected. For these reasons, we’ll continue to revisit our strategy with respect to Europe, and consider whether it’s time to go back to an underweight position.
Bottom Line: While recent inflation news is encouraging, we expect the European economy to remain stagnant through the end of 2023.
Bonds
With the U.S. Federal Reserve signaling a pause on rate hikes at their next meeting but leaving the door open for more increases later in the year, what’s the status of the bond market? In general, we still like bonds from a price standpoint. Certainly, the possibility of further monetary tightening, both in the U.S. and Canada, adds some pressure. But with bonds up around 2-3% this year and GICs yielding 5%, if you extrapolate to the end of the year, bonds could still outperform GICs, which is what one would expect. The additional upside we see with bonds is that if markets do experience some difficulty, bonds could receive a lift because of the possibility of a rate cut, which isn’t the case with GICs. Even just the signal of a pause should be a positive for bonds because it means we’re getting closer to that much-anticipated monetary easing. The one thing that investors will want to be careful to avoid is getting into the lower-quality space. Given rate hike risks and the potential for an economic downturn, we recommend sticking with quality, same as in equities. We have been adding a little to duration, but not too much too fast; we’d like to hear more from the Fed before deciding where to go on the curve. And at present, we prefer bonds over cash.
Bottom Line: For now, it’s wise to maintain exposure to bonds, because they can serve as diversifiers and will generate an attractive yield.
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?
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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