Monthly Market Musings

December 2023

Taking Stock Of Where We Are Following A Volatile Fall Season

We noted back in September and October that the historical pattern of weakness in the early fall months was likely to set in. Our view was that this would likely create buying opportunities for investors as the negative sentiment and uncertainty of the central banks’ next moves were still unclear and that this would be followed by a rally shortly after. This is how things are playing out as we have seen a strong recovery in November with the S&P/TSX Composite Index (TSX) and the S&P 500 Index (S&P) rallying approximately 7.5% and 11.5%, respectively, from their October lows.

The November rally has been helped in part by the third quarter (Q3) earnings results which have proven to be better than expected. 487 of 500 companies on the S&P 500 Index have reported their Q3 results with 394 of those posting earnings beats. The average earnings have come in at about 7.7% above the consensus forecasts. As for the companies on the TSX, 211 out of 226 have reported so far as of the writing of this article. 107 have topped analysts' earnings expectations and the average earnings surprise of about 3.2%[1]. As we entered 2023, the general view amongst analysts and strategists was that consensus earnings estimates were way too high and needed to come down significantly throughout the year. And this is what happened, many analysts lowered their earnings estimates. However, corporate earnings were more resilient than anticipated and this resulted in a high percentage of earnings surprises every quarter this year so far. Was this a case of too much pessimism built into the forecasts or did the economy just fare that much better than was expected? While it was probably a combination of both of these things, the outcome is that the percent of companies topping expectations is near historical levels and corporate guidance is still looking somewhat promising. Despite this, many investors and strategists still seem to be hesitant and are taking a "wait and see" approach to the equity market, opting to hold more cash and trying to lock in higher rates while they are still available. While an argument can be made for some allocation to cash and fixed income at the current rates, at some point, when the rate cutting cycle becomes the prominent theme, capital will flow back towards equities in search of higher returns. As rates ease, corporations will experience reduced expenses and a cheaper cost of capital which will improve the bottom line and help sustain their earnings growth. Recently, October Canadian Consumer Price Index data showed annual inflation easing further to 3.1%, this was a big slowdown from the 3.8% pace seen in September. While much of that month-over-month decline stemmed from the pullback in gasoline prices; food prices, mortgage interest expense, and rent continued to drive the overall number. As inflation continues to slow, we are beginning to get a clearer picture as to when potential interest rate cuts could happen. At this stage, many are suggesting that this could happen as early as the second quarter of 2024 at least in Canada.

While there continues to be unanswered questions surrounding the overall economic environment, with interest rates worries, the continued geopolitical tensions amongst others, investors should take solace in the fact that the markets and corporations, in general, seem to have managed the situation quite well thus far as mentioned above. We believe that the September and October weakness along with the better-than-expected earnings season could set the stage for a continued year-end rally as we close out 2023 and the focus shifts to a less opaque 2024. With this in mind, the best course of action is to remain invested in equities which will provide the best option for above average returns from an asset class perspective. Equities typically outperform leading into and during rate cutting cycles[2]. That said, the coming quarters are likely to continue to exhibit high volatility and high anxiety will remain persistent among investors. Investors should do two things to help with this situation. First, investors should, as we have previously noted, remember that time spent invested in the market will always result in higher returns than attempting to time the market over the long run. Secondly, investors should stick to high quality names within their equity selections. We define high quality as names which have a history of stable revenue and earnings growth, healthy balance sheets, solid potential for profitability with consistent margins, and low drawdown risk from a historical standpoint. A diversified portfolio with these type of high quality names will help moderate volatility and should reduce investor anxiety.

JAY SMITH, CIM, FCSI

Senior Portfolio Manager & Senior Wealth Advisor          
 

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