As we go into the long weekend, we welcome the Summer Doldrums! It has been, surprisingly, the opposite of that, and not just with the wild rainstorms and hot humid days, but the markets too have been turbulent. More importantly, we are still in the GREEN ZONE and mostly invested, but as we mentioned in the last e:Newsletter, we are, and continue to be, very much defensively positioned.
We usually expect volatility throughout the summer simply because the majority of the big traders, institutional and pension money managers go on vacation, leaving the trading desks empty. That results in less liquidity in the market, and as it is with less traders, it only takes one or two big trades to move markets. We have been, however, seeing much more than just a little volatility as inflation and interest rates concerns continue to dominate the financial pages. As markets have had a great run from the bottom of October last year, many investors are concerned with a top, especially in the technology and growth stocks and the “Magnificent Seven”: Alphabet (also known as Google), Amazon, Apple, Meta Platforms (better know as Facebook), Microsoft, NVIDIA, and Tesla. The worry is that the top may be looking similar to the tech bubble of 2000.
The following stock chart is a “relative” comparison of the Technology Stocks (represented by the XLK ETF) to the Broader Stock Market (represented by the SP500). Those technology stocks peaked in 2000 before the break of the bubble bottoming out in March of 2003. They are only now returning to that peak – on a relative basis (noting of course that both markets on an absolute basis are much higher).
The question we are posed with now is, can markets break through the top line (in grey), or will that present too much resistance, resulting in tech markets falling again relative to the rest of the broad market and economy?
As of writing, tech markets (the Nasdaq QQQ ETF) are down 10% from their highs from July 11th. Specifically, Nvidia, the computer chip maker that has been the stalwart of the tech stocks, is now down 23% from its highs. They are all currently sitting on very important lines that must hold. Failure to do so would see us continue to be even more defensive.
In Canada, we have seen rates drop half a percent year to date and likely with more cuts to come. Our economy is not yet in a recession but appears to be bordering on one. We need interest rates to come down for two main reasons: (1) to stimulate the economy and thus, allow us to pay our increasing government expenses and enormous debts, but (2) to also reduce the risk of mortgage, loan, commercial loan and business defaults. Note in Canada, we typically have fixed term mortgages up to 5 years. Many borrowers pre-Covid locked in at great rates but are now approaching renewals at much higher rates. Both personal and commercial borrowers are now faced with huge increases in their monthly payments and delinquencies, defaults and bankruptcies have already begun. It is also the reason why Canadian Banks, which have always fared dependably well, have had to put aside significant amounts of reserves for potential defaults, and in turn, their stocks are all still down anywhere from 8% to as much as 33% from their highs.
The Canadian government spent more per capita during the pandemic than any of the G20 countries. The latest budget was a "tax-heavy, spend-heavy” budget and has not helped grow the Canadian economy.
Immigration, as honourable as it is, can be argued as overzealous and some may say that it has now put a serious strain on resources and is pushing housing and rents higher, and for many, beyond realization. The need for lower rates in Canada was necessary and was ultimately why we saw Canada move rates down last week and before most other countries.
The problem is that we cannot stray too far off US Rates or it will negatively impact our currency and buying power significantly. As of writing, we are at an exchange rate of $0.72 USD/CAD, which is a range that we saw in 2020 (due to Covid) and in 2016 and 2004. Prior to that, the lows were $0.62 in 2002 and while we could still head there, I am hoping we don’t ever see that again.
In the U.S., the economy has been much stronger, and inflation, like it is in Canada, is quite sticky. So far, they have held rates tight in an attempt to get inflation down further. The big fear the US central bank, “the Fed”, has in lowering rates too early is that it could simply spur inflation once again. It is a tight line to walk. On Wednesday this week, the U.S. Fed stated it is reiterating holding rates for now but made it apparent that we would probably see a rate cut finally come in September. Markets quickly jumped significantly higher that day, particularly growth stocks, on the expectation of lower rates making it cheaper to do business. Unfortunately, we saw some very weak job numbers and other economic reports from the U.S. are indicating that the economy may be seeing some headwinds. With that, the sentiment of concern prevailed on Thursday, and as we stated above, the same tech markets that jumped initially are back down sitting on very important resistance lines.
On the positive side for U.S. banks, they do not have as much of an issue with mortgage defaults because US borrowers often lock rates for 30 years. Their economy is also significantly stronger, and we are seeing a broader range of stocks, such as small to mid-sized companies, financials, industrials, health care, etc. (all the backbone of the U.S. economy) recently beginning to take over the leadership role in stock performance. Even though we have heavily reduced our exposure to tech and growth-related stocks, other parts of the market are beginning to do well. We have therefore shifted our focus in those directions, allowing us to remain invested.
We are well past the two year anniversary of the Ukraine / Russia war and still, we see no end in sight. More importantly, this war has not expanded. There are no boots on the ground by those supporting either side, and as long as that remains the case, we don’t worry so much from an investment point of view. As for the Israel / Hamas war, it may, however, be expanding. Hezbollah has stepped up its fighting and rhetoric and Iran is now talking about its need for responses to recent events. Should that war expand, meaning other countries surrounding them like Jordan, Egypt, Saudi Arabia etc., and most importantly, the U.S., Britian, France or even China get involved by putting boots on the ground, investors may flee from stocks to safe havens such as US treasury bonds and cash. We currently have good exposure to energy stocks and gold as part of our defensive model and these will become significantly important should issues ramp up.
If you had asked us a few weeks ago, the US election was the Republicans to lose. Since then, the Democrats substituted Kamala for Biden and their prospects have improved dramatically. They are seeing a nice bump and now leading and will do so as they go into their convention in a couple weeks. We prefer to look at the online betting over the political polls as they have seemed more accurate in the past of number of years. In particular, we watch the following betting site. It is a project of Victoria University of Wellington called “PredictIt”, and has been established to facilitate research into the way markets forecast events.
2024 Presidential Election Predictions & Odds | Who will be the next president? (predictit.org)
They are now showing the Democrats leading, but once the convention bump is over, the real competition begins.
Elections cause volatility and we are also going into the more volatile period of the year from a seasonal investing point of view. As such, we will likely remain on the defensive until we get close to the election. Investors tend to get excited as the end of the long four-year cycle is nigh, and at that point we will likely ramp up our investing and return to offense.
Should the Democrats win, markets will be happy again that the cycle is over. Should the Republicans win, they will probably be more excited and push markets higher simply because they tend to be more bullish on lower taxes, lower regulations, and being business friendly. Our only concern, as is for most investors, is that neither party captures control of all three positions: the Presidency, the House, and the Senate. As long as one party has control of one of the three, then they can provide that balance of power versus the other two. Hence, the government is restricted to what they can push through. Markets like governments in a stalemate – they can’t do as much damage.
Although there is now and always lots we can find to be concerned about, stock markets are holding their own for the most part. We still have positive sentiments on the markets and we remain in the Green Zone. It is important for us to continue to evaluate all different markets and sectors. As such, while we are moving our focus away from tech, we still remain invested. We are seeing the typical rotation to more broader markets and sectors like US banks, Canadian and US industrials, and small to mid-sized companies.
From now until late October, we expect to be in the season of higher volatility leading up to the election. As such, we reiterate our stance as we have for some time -- “one foot on the gas and one foot on the brake”. We are looking for the upside positions and sectors of the market that are improving, but also protection for any downside the volatility could cause.
Best regards,
- John