Q3 and Market update
For the quarter, the S&P 500 fell about -3.6%, the Dow lost -2.6%, the Nasdaq shed -4.1% and the TSX was down -3%. The Dow and TSX are also negative on the year at -0.30% and -2.55% respectively.
How are we positioned moving forward?
The bond opportunity remains as some say a “generational opportunity”. In other words, a great time to hold quality bonds!
The key is to own mandates that have the ability to be flexible and tactile, meaning the ability to go to any geographic region and the ability to buy the best risk adjusted yield available, whether it be sovereign issues (i.e., Canada sovereign bonds, US T-bills etc.) or corporate issues. Having a tactile and opportunistic approach is vital in finding returns and mitigating downside risk. The opportunity is a real one though. What hurt the bond market in 2022 into 23, was the largest interest rate increase the economy has ever seen. However, this has now created great opportunity and has in essence reset the Bond markets, in that, new offerings are being issued with rates we have not seen since the credit crisis in 2007.
As we near the end of the interest rate increase cycle, (we are likely in the 9th inning of this play, further backed by today's rate announcement by the Bank of Canada to hold rates at 5%), as rates flatten and especially as rates begin to decrease (most believe this will begin Q2 or Q3 2024) the value opportunity in Bonds is a real one and we will begin to separate from general markets.
The Bond Thesis has been delayed because we have been resilient with the consumer. For example, we had good savings rates and we had good debt levels in terms of credit cards. But this has changed. So where does the balance of risk lie over the next 3 months from an economic perspective? We think the risk remains to the downside, but...the upside is in Bonds. And this is key. The opportunity in bonds has not gone away, it has simply been delayed. That is one of the best parts of investing in Bonds, is that it is mathematical...you know, with high confidence, that high quality bonds will mature at their maturity date. Bonds aren't like equities. Patience is important because the interest is not paid daily. We can't look at them every day to see interest payments. We need to hold them for the full year to realize the full yield i.e., 5%, 6% etc. The patient bond investor will be rewarded.
With equities, Dividend paying corps that have little to no debt, have strong cash flow, pay increasing dividends each year and lead their specific industries are the type of equities a long-term value investor should hold both during these markets and moving forward. Current valuations are very favorable for many corporations and below historic averages for many indices and specific stocks. A combination of quality Bonds and Dividend paying equities is how a tactical portfolio should be designed moving forward.
Below is a summary of key points:
1- Slower global growth
Economies around the world are starting to show signs of slowing, due to significant increases in interest rates. Up to now, economies have stayed strong, thanks to consumer activity (which accounts for two- thirds of economic output). Consumers had excess savings after COVID lockdowns, higher wages, and a robust job market. However, there are signs that consumer support for the economy may be weakening, with declining savings rates and early job market problems. These developments could slow down the global economy in the near future.
2- Interest rates
The weakening North American economy will likely lead the Bank of Canada and the U.S. Federal Reserve to pause their interest rate increases in the coming months (as shown with Oct 25th BOC announcement to hold rates at 5%, the next BOC rate decision is scheduled for Dec 6th). Inflation has fallen significantly from last year’s highs. Central banks are careful not to harm economic activity by being too aggressive, and it’s expected that interest rates will be lower a year from now.
3- Stock market trends
Higher wages and inflation have affected corporate earnings, causing declines of 6% and 12% for U.S. and Canadian companies, respectively. While earnings are expected to recover in the second half of 2024, there may be some uncertainty before that happens. The good news is that not all companies will be affected in the same way. Companies that are financially solid with strong profit growth as well as products or services that are hard to replace, are likely to fare better in the future.
4- Fixed income opportunities
It’s important to remember that bond prices move the opposite way to interest rates or yields. Bonds are currently offering yields not seen since 2007. For example, highly rated Canadian corporate bonds, as of the end of Sept 2023, currently provide an average yield more than double the yield that was offered at the beginning of 2022.
5- The impact of AI
Artificial intelligence (AI) may have a big impact on the broader economy, investments, and society in the future. But there are many unanswered questions. It’s worth noting that being the first to adopt new technology doesn’t always lead to a lasting advantage. Think about the progression from the Palm Pilot phone to the BlackBerry smartphone, which was eventually replaced by the iPhone. Many believe that there’s a bit of euphoria surrounding AI right now, and it’s wise to approach the current AI trend with a healthy dose of skepticism.
6-What lies ahead?
While market volatility is expected to continue for the rest of the year, it’s important to remember that trying to time the ups and downs of the stock market is nearly impossible. Just look at last year’s events. In September 2022, the S&P 500 dropped 9.3% and recovered 8% the following month. Over the next 9 months, the index was up nearly 15.0%. It’s crucial to stay focused on your long-term financial goals and not to allow short-term market fluctuations to distract you.
As always, I'm here to talk if you have any questions about the markets or your investments...happy to help!
All my best,
Roger Banks Registered Retirement Consultant