Welcome to June and the unofficial start of summer for the stock markets. As Memorial Day passes in the U.S., investors, particularly institutional investors, begin to wind down trading activity as we lead into the summer doldrums – the time of year with typically low volume and interest from professional traders. That said, there is still obviously lots of information for all those watching the markets to continue to be interested and engaged.
We are in the Green Zone in our longer term Stoplight signal, but it is teetering still on going into the Yellow Zone. Our more important Price Action – or Footsteps as we like to call them, are doing the same. Markets are doing their best to break higher but are still stuck in the same range for the past two months. The U.S. Dow Jones broad market is down from the open on the year, while the Canadian S&P/TSX is barely positive, having come back down in the past two months.
The only bright spot has been in the Growth stocks which continue to show strength, but are still very much dominated by just a few of the larger companies. It is here we are currently focused, but we remain concerned in the face of potential negativity in the economy and political scene.
The most obvious and current concern is the need for the U.S. to resolve the Debt Ceiling situation before a potential “default” on June 5th. On Wednesday, it passed the first major step and vote in the House of Representatives. It now must go thru the U.S. Senate where there is expected to be resistance from the extremes on both sides. Our view is that a deal will get done, or worst case, again a resolution to “kick it down the road” until September. In either case, markets should see a sigh of relief - and we move on..
Investors will be back to focusing on inflation, rates and the state of the economy. Rising rates are a focus as they can damage the current strongest part of the market – the Growth Stocks. They do not do as well during times of rising rates as it is more expensive to manage and grow the business. It also causes the U.S. dollar to increase in value, thus causing foreign revenues, a major component for those companies like Microsoft and Facebook, to decline.
There is still a wide disparity on the views of whether we will see interest rates rise further, whether we will move into a recession, and how soft or hard the recession will be. In Canada, surprisingly our GDP numbers don’t look too bad. But Germany, Britain and other countries globally are not in the same position. The U.S. is teetering and the numbers coming in remain mixed and confusing. The U.S. Federal Bank reps all seem to be split on where we are and more importantly on the need to move rates higher to squash inflation or not. Should they indicate rates will move higher for longer, it will potentially increase the likelihood of a recession, and the chances for a deeper and more prolonged one. Should they consider a pause in rate increases, the risk declines.
On the state of the U.S economy and outlook for rates, we provide the following comments from our BMO Economics Department:
BMO Economics EconoFACTS: Beige Book — Consumers Remain Resilient
Erik Johnson, Senior Economist
The latest Beige Book, prepared by the Chicago Fed, with info collected on or before May 22, noted “little change” in overall activity, though consumer spending—the biggest economic pillar—was “steady or higher in most districts” led by the leisure and hospitality sector. However, expectations for future growth “deteriorated a little”. So, resilience remains a recurrent theme so far this year, but higher interest rates are beginning to point to slower activity ahead. Nowhere is that more evident than the demand for transportation services where contacts reported there was a “freight recession.”
On credit conditions… Overall, lending conditions were “stable or somewhat tighter”, but consumer loan delinquencies are on the rise back to pre-pandemic levels. Among the Districts, the New York Fed reported that conditions in the finance sector “continued to worsen” at a similar pace to the last report while both the San Francisco and Chicago Fed reported modestly worse conditions. At the other end of the spectrum, the Philadelphia Fed found that bank lending grew moderately in the district—exceeding the pace of growth over the same period last year.
On inflation… Prices rose “moderately” due to “solid demand and rising costs”, but the pace is slowing in many Districts. Additionally, several Districts reported that consumers are showing greater price sensitivity than the previous report.
On the labour market… Employment increased in most Districts, though the pace appears to be slowing. Firms are still “reporting difficulties finding workers across a wide range of skill levels and industries”, though some Districts reported easing conditions in construction, transportation, and finance. One anecdote from the Kansas City Fed, suggests that the gap between normalizing hiring rates but still elevated job postings could be related to firms becoming more selective in their hiring.
Bottom Line: The Fed’s regional report card, prepared for the June 13-14 meeting, suggests that, while activity was little changed, household spending and the labour market remained resilient. There's something in the report for both hawks and doves to point to, and so the Fed's decision to pause (or not) will likely hinge on the May jobs report and CPI data.
And the good news as of writing is that the U.S. Fed is now at least talking about a pause or more likely a “skip” for increasing rates in June, until the next data feeds and the next meeting on July 26th. This news should be a relief for investors for now, reducing their confusion and likely volatility.
From a technical point of view, we continue to watch a number of charts and the Price Action Footsteps rather closely. As we mentioned in the last e:Newsletter, the charts for Financial Stocks remains weak. We can look at the U.S. Financials as a basket or even any Canadian Bank. They all remain at lows and are failing to break higher. If financials won’t go up, then stock markets typically cannot sustain any momentum to move higher. We also look at small to mid size companies, which are the backbone of any economy. The charts of these companies as a group are also quite weak, sitting at their lows. If the economy weakens, they will not be able to breakout higher. And finally, we look at volatility. In this case not for stocks, but for bonds. Bond volatility for the first time in any recent history, is surprisingly much higher than that for stocks. The bond market may be telling us something. And lastly, without sounding too dark, there is a similarity in technical setups to that of 2002 and 2008 where the markets had a second wave down. That said, it was also potentially there in 2020 but never resolved to the downside.
Bottom Line:
We are in the Green Zone, albeit on the edge, and our focus on Growth Stocks, at least for now is moving us higher. We expect a resolution for the Debt Ceiling which will see stocks potentially break out above resistance to do so. And though numbers are mixed on the economy, the Central Banks around the world will be looking for reasons to halt further interest rate increases. Not raising rates reduces the risk for recessions, or at least for hard landings. And as stated above, the U.S. Fed is already telegraphing a potential pause or “skip” for June until they have more data to work with.
Market moves are somewhat tentative from here and will likely be news and catalyst dependent. We will continue to be cautious and proactive. Overall, we are positive on the potential outlook and particularly for the Growth and stronger components of the market.
Have a great weekend!