It is nice to see the green leaves sprouting on the trees and the flowers all blooming as we move into May. Like the season, we continue to hold into the Green Zone on a longer-term basis in the markets globally. On a shorter-term basis, markets remain “messy”, and therefore, in the short-term indicators, we are more cautious and in the Yellow Zone.
After a great first quarter, markets have pulled back from their highs of late March. In the month of April, major indices have all seen a decrease, with the U.S. S&P 500 losing -4.16%, the U.S. Dow Jones Industrial Average losing -3.75%, and the U.S. Nasdaq, consisting of mostly tech and growth stocks, losing 4.41%. The Canadian market, TSX Composite, lost -2.04% in April as well, while the U.S. Russell 2000 stocks lost -5.55% over the month, indicating the weakness in smaller to mid-size companies.
We are now traditionally entering the weaker period of the year for the equity markets as we wait to see if the “sell in May and go away” theme takes hold this year or, considering this is a US Election Year, if the May theme decides to take a break this time around.
A correction is a sustained decline in the value of a market index and is generally agreed to be a 10% to 20% drop in value from a recent peak. With the pullback we have seen, we would therefore not call this a correction and so far, we do not expect it to evolve into one. It has been more of a healthy pause after the run from the lows of late October. The longer term “Bull run” is still intact.
We have seen many stocks, and especially the growth stocks that were the leaders, rollover. Many are close to their three months lows (noting that is short term). Instead, we had begun to see commodities move higher and taking over the leadership, but in the past few weeks, even those are also stalling out. Gold, for example, has not recently been acting as the safe haven it is expected to. Energy too is off its highs. We may need to lighten up on both if they do not hold at their current levels.
Thusly, we used the word “messy” above. Markets generally remain so – even in the context of a bull market. This could continue to do so for some time. Markets may pull down a little more, but more likely, they will go mostly sideways from here until we see some sort of catalyst to drive them in either direction. Until then, we are on the defense, sitting in a fair bit of cash or related investments until we have a signal of where to go from here.
It was the expectation that interest rates would be coming down that pushed all markets higher through the end of the last year and into the end of March. Since then, inflation has remained sticky, and therefore, interest rates have not come down as investors had originally expected and hoped. Higher rates make it more expensive to do business, and for individuals, high inflation and high rates makes it more expensive at the grocery store, the gas pumps, and of course for borrowing. In the U.S., it is now likely that it will be at least September before rates decline. The fear in the market is that rates may still go up. We spend a lot of time looking at charts of the U.S. bond market and U.S. dollar. They continue to hold their highs of the year, telegraphing that rates are not coming down soon. Here are the comments from BMO Economics on U.S. rates:
FOMC Monetary Policy Announcement: May Day Rate Stay
BMO Capital Markets Economic Research • Douglas Porter, CFA, Chief Economist, Michael Gregory, CFA, Deputy Chief Economist
The FOMC kept policy rates unchanged on May 1, with the fed funds target range at a 23-year high of 5.25%-to-5.50%, which is where it has been since July. Amid the policy pronouncements, there was a sense the range could remain here for many more months. For “as long as is appropriate”, as Chair Powell put it in the presser.
There were two major changes in the policy statement. Added in the opening paragraph was the phrase: “In recent months, there has been a lack of further progress toward the Committee's 2 percent inflation objective.” Assuming it’s going to take at least three months of good inflation performance to potentially turn this phrase around, this means the Fed has moved further away from cutting rates any time soon. It’s also a subtle walking back of the scenario portrayed in March’s Summary of Economic Projections in which the median fed funds call was for three rate cuts this year.
The other major change was the announcement on quantitative tightening (QT). The monthly run-off cap for Treasuries was lowered to $25 billion from $60 billion beginning June 1st, with the (non-binding) MBS cap remaining at $35 billion. And when these payments ever get above the cap, they’ll be reinvested in Treasuries. The tapering (of Treasuries) was a bit more than expected, likely reflecting the Fed’s heightened sense of caution as QT gets more fully reflected in reserves reduction.
Also in the press conference, Powell said, despite the poor inflation start to the year, rate hikes are still “unlikely” (which is how he portrayed them back in December). Although he’s less confident than in the previous meeting, Powell still expects inflation to move down “over the course of the year”.
Bottom line: The Fed’s on hold and is happy to be there for as long as it takes.
Here in Canada, we expect rates may begin to decline come July, as our economy is much weaker than the U.S., which is rather frustrating as oil and commodities are all stronger and usually good for our currency and economy. However, with U.S. rates remaining higher for longer, it will be more difficult for the Bank of Canada to move as soon as they would like. Note we will have more reports out later on Friday with the Weekly Focus, but here is the most recent report from BMO Economics again, on the Canadian economy:
Canadian Monthly GDP (Feb.) — Flash in the Pan
The Canadian economy grew a moderate 0.2% in February, a tick below expected and half of StatsCan’s flash estimate. Adding to the softness, January's gain was revised down a tick to +0.5%. February growth was led by mining/oil/gas, transportation/warehousing, hospitality and finance. However, eight sectors contracted in the month, and seven have activity below year-ago levels, highlighting the challenges facing the economy.
Statcan's flash estimate for March GDP came in at flat, which isn't a surprise after the weakness in earlier data. And, the estimate for Q1 growth is around +2.5% annualized, bang on our call and a touch below the BoC's 2.8% forecast. The start of 2024 looks eerily similar to 2023, when the economy started the year with a bang, only to stall after Q1.
Key Takeaway: While Q1 looks like it was decent overall, the loss of momentum as the quarter progressed is the bigger takeaway from this report. That puts additional pressure on the BoC to begin cutting as soon as June (which is still dependent on CPI in a few weeks). Unfortunately, persistently strong U.S. data are making things increasingly complicated for the Bank, as it appears that the Fed could be on hold for a while.
The war in Ukraine and Russia sadly continues endlessly on. The U.S. Congress agreed to provide the Ukraine with more funding, but they are losing this war to Russia. Israel also received more funding in support of their war versus Hamas, despite antisemitic uprisings by the left and at universities around the world.
From an investments point of view, this has caused volatility of course, but has not seriously disrupted markets. As long as the war does not expand, meaning getting other countries involved, or more importantly the U.S. not putting “boots on the ground”, then we do not expect these events to cause any serious market breakdowns.
The U.S. election coming up in November this year is usually good for the stock markets as we have already seen to date. At this point, it is still anyone’s guess who will win. Both sides have a representative that is quite a bit older and not well regarded by those voters in the centre. Here is an interesting piece from Greg Valliere, an excellent Washington Insider, whom we have highlighted before and had a client conference call with in the past. He outlines the current issues for both sides.
These Five Issues Will Determine the Election
Greg Valliere, Chief U.S. Policy Strategist, AGF Investments
CALL US OLD-FASHIONED, BUT WE THINK ISSUES MATTER, and there are five of them that will have a major impact on the presidential election. These are the ones that could move the needle as the campaign heats up:
1. Abortion: The public clearly believes that Republicans have been too strident on the issue. Strict abortion bans have been rejected in the past year in the conservative states of Kansas, Alabama and Ohio, and this week nervous Republicans overturned an 1864 law that criminalized the procedure in Arizona.
Most Republicans — including former president Donald Trump and Arizona Senate candidate Kari Lake — say the 1864 ruling went too far. Republicans can read the polls, which show that 59 percent of Arizona’s registered voters think abortion should be mostly or always legal. In private, Republicans say abortion could be a game-changer this fall. Advantage: Biden, clearly.
2. Immigration: We still can’t figure out why Biden didn’t have a clear plan a year ago. He apparently thought he could avoid tough choices, and then came the surge of illegal aliens — over a quarter million — that streamed into the U.S. just before last Christmas.
This is not just an issue in the Southwest; it has swamped big city mayors, who lack the resources to feed and house the immigrants. It’s highly unlikely that legislation could pass before the election; the Republicans are happy to make this a huge campaign issue. Advantage: Trump, overwhelmingly.
3. The Economy: This is usually first or second before a presidential election, and Democrats are nervous. Inflation has not been defeated; prices are still rising, perhaps not as fast as a year ago, but the Federal Reserve won’t cut interest rates until fall or later. We’re getting close to the period — usually in the summer — when public attitudes on the economy traditionally harden. Unless inflation plummets, this will be still another albatross for Biden. Advantage: Trump, clearly.
4. Crime: Statistics show a drop this year in urban crime, but try telling that to voters in big cities like San Francisco or Washington, where swamped police forces have re-defined what is a crime worth investigating. Simple auto thefts don’t always make the cut, as residents of Toronto will tell you. Advantage Trump, who claims he will call out the National Guard as campuses explode.
5. Geopolitics: Biden’s poll numbers on foreign policy are terrible, as young American males increasingly embrace isolationism, arguing that foreign aid should be spent on domestic issues, not far-away Ukraine.
THE DEMOCRATS’ NATIONAL CONVENTION, in Chicago from Aug. 19-22, could resemble the disastrous Chicago convention in 1968, with the Vietnam war dooming the candidacy of Democrat Hubert Humphrey. Clear advantage: Trump, as Biden desperately seeks truce talks in Gaza and Ukraine.
BOTTOM LINE: It’s still too early to make an election call, but nervous Democrats in this city are distancing themselves from Biden. He could still win — Trump sounded incoherent at campaign events yesterday, as his 78th birthday approaches.
MAYBE THIS WILL BE AN ELECTION that largely focuses on personalities, but these five issues are important, and they point to an inescapable conclusion: Biden is in trouble unless he can make the election all about abortion.
From an investment point of view, we do note that markets don’t really care which party wins. They are more concerned that the election is over and done, and most important, that one party does not control the Presidency and both the House and the Senate. As long as either party has at least one of the three, then it is harder for any major legislation or “damage” to be done. A government that is restricted from doing too much is comfortable for investors and the market.
Regarding the state of the markets in the actual lead up to the election, our BMO Technical analyst; Russ Visch writes this with respect to historical market moves in the few months prior to the U.S. election:
Here's an interesting curveball for the macro call. Short-term momentum gauges for the U.S. 10-year yield have rolled over and gone negative, which suggests the next major move will be a test of multiple support levels in the 4.35-4.45% zone and perhaps as low as the 200-day moving average at 4.30%. That would be a solid near-term tailwind for equity markets and may push out any significant corrective action in stocks until the summer, which is more in line with seasonal tendencies. We're still working under the assumption that equity markets undergo a more pronounced/prolonged correction through the middle months of the year though. Every U.S. presidential election year since 1950 has had a solid pullback in late Q2 or early Q3 as investors scale back risk during that period of uncertainty. More importantly though, the weakness in the first half of April half had a materially negative impact on our medium-term timing model. Weekly breadth and momentum oscillators have rolled over and gone negative from some of the deepest overbought readings in years and bullish sentiment is contracting sharply as well. This suggests the recent short-term pullback is likely developing into a more pronounced medium-term pullback similar to what occurred last summer. Back then we saw the major averages sell off 8-10% over a three month period from late July to early October. If that's the case, then a test of 200-day moving averages is likely at some point in late Q2 or early Q3. (TSX: 20,643, SPX: 4700) The key level to watch that will tell you the medium-term pullback is underway in earnest are the late April lows from a week and a half ago. (TSX: 21,536, SPX: 4953)
Given the technical outlook and history of the markets preceding U.S. elections, we will look to be rather cautious during the early summer period thru to the election in November.
Markets are in a much-needed pause after the run up in markets. Markets that continue to shoot straight up unchecked eventually go straight down. We would rather see market lines move in a zig zag pattern. Move up… pause or consolidate… move up again. That is a healthy market, and so far, that is why we are in the Green Zone with what we are seeing mid to longer term.
The bull market is still intact. Inflation and interest rates are not dropping but are still holding from going higher. We are in a U.S. election which is typically good for markets, while geopolitical concerns are in check thus far.
Shorter term markets are seeing higher volatility and our indicators have us in the Yellow Zone. It also had us increasing cash and defense to protect on the downside should there be some actual surprise catalyst to push us into correction phase. We do not see that yet nor any reason to anticipate that larger downside.
We think it is important to note that we continue to be very proud to be part of the BMO Team. BMO is now the eleventh largest bank in North America and that provides us with the ability to best support our clients in all their needs. Should you have any questions or concerns for the market or would like to discuss your portfolios or personal investment, financial or estate plans, our Team and supporting BMO Specialists are always pleased to meet in person or by video or conference call.
Have a great weekend!
John, Victor, & Megan.