MONTHLY MARKET MUSINGS

July 2023

2023: 6 Months Gone, 6 Months To Go

U.S. Central Bank Pauses Its Rate Hikes

Investors would be happy to learn that historically, the markets have generally rallied following a pause in a U.S. Federal Reserve (Fed) rate hiking cycle. That said, the current hiatus is more likely to be a temporary pause with two more 25-basis point hikes expected in the coming months. If the underlying assumption is that these are the final two rate hikes of this cycle before we enter a period of declining Fed Funds rates, then this could set in motion the reversal of several trends which have been building over the past 6-12 months. One is the triggering of money market outflows. Cash levels grew alongside interest rates as the risk/reward on cash and cash-equivalent securities improved as yields rose. Many investors could not see the purpose in taking on more risk than necessary when money market instruments were in some cases yielding more than 5% and this led to significant capital moving into this asset class. Now with the final expected rate hikes being priced-in, we may see a shift from money market products back into equities as the upside on yields is limited. In addition, the market has experienced a growing number of short positions over the past year and flows back into stocks could trigger a squeeze on some of these positions which would further add to the potential upside in equities.

While the U.S. Fed continues to weigh the trade-off between tempering inflation by raising rates and avoiding a severe recession due to those higher rates, most economists seem to agree that a deep recession is likely avoidable but that signals as to whether we will have a recession or not are a little murkier. Recent jobless claims data has shown some of the highest claims numbers in some time which suggests a weakening economy that could lead to a possible recession. It is worth noting that while jobless claims are rising, they are still quite low from a historical standpoint. Bullish sentiment has been strong though and the market, which is a forward-looking mechanism, seems to view any negative economic data point as "more reasons for the Fed to pause" and then proceeds to look past it toward the 2024 expected rate cuts. This is perhaps a bit too hopeful given the general uncertainty of the impact of the Fed's actions but seemingly, the market seems to be looking past the hiking cycle. While the trajectory of the markets is likely higher in our view, with volatility rising from its lows to a more normalized level, the market could experience choppier trading in the coming months.

How To View Equities Right Now

The U.S. equity indices have been the clear beneficiary this year of the rally in the technology sector. Following a very weak 2022, this sector has rallied significantly helped in large part by the enthusiasm surrounding generative AI (Artificial Intelligence). This has enabled the U.S. indices to outperform their Canadian counterpart, but Canadian equities are beginning to look more attractive relative to the U.S. names in terms of their historical valuation multiple. It is worth noting though that the weight of some of the largest names constituting the U.S. index has skewed the overall aggregate valuation. This means that when those largest names in the U.S. are excluded, the U.S. index valuations begin to look more reasonable and more in line with historical levels. The takeaway is that while the U.S. mega-cap names could continue to see growth in the coming months, there may be better opportunities in the names that are slightly smaller in terms of market cap.

JAY SMITH, CIM, FCSI

Senior Portfolio Manager & Senior Wealth Advisor
 

BRAD BROWN, MBA, CFA
Portfolio Manager & Associate Investment Advisor