It is September -- the time of the year where we see the large institutional traders and pension funds return to the office from the summer doldrums and look to rebalance their portfolios for the quarter. As this happens, we seasonally see the volatility of the market pick up, and in addition, we are also in the countdown to the end of the U.S. election cycle, adding more uncertainty and further potential volatility. We are still in the Green Zone in our mid-to-long term Equity Action Call – the Stoplight, but our shorter-term indicators are signalling the need for caution.
The markets opened the month of September down from their recent highs. Tech, growth stocks and other “risk on” assets, which have been the leader for the past year, are now wavering the most. We expect to see more of this until mid-October as the institutions and investors generally get repositioned for the end of the year and for the typically late fall and Santa rallies. As we have reiterated for the past couple months, we will remain with one foot on the gas and one foot on the brake until mid-October when we will load up going into the end of the year and the election.
We are pleased that despite the recent volatility, we ended off the month of August at approximately +2.9% in our “Equity Component” of the portfolios for August and about 18.7% (and for the Large Total Equity Model Portfolios) for the year to date. In comparison, the Nasdaq (hedged) was up 15.76%, the SP500 (hedged) was up 17.76%, the Dow (hedged) was at 10.05%, the TSX was at 11.78% and the Canadian Broad Bond Index down -0.7% year to date. Moreover, our Large Growth Model Portfolio was up approximately 18.17%, the Balanced Model was up 14.8% and our midsize model portfolios have performed similarly. Note that some accounts may differ slightly from the model, but all numbers above are quoted after fees.
As discussed above, we do expect a fair bit of choppiness in the markets for the next 6 weeks or so and that will see us more focused on downside protection until then. We are inclined to fully agree with the technical notes from our BMO Nesbitt Burns Portfolio Management Team:
Technical Analysis - September is traditionally the weakest month of the year for stocks both here in Canada and the United States. Over the past few decades, the average return for the S&P/TSX Composite Index in September is -1.57%, and -0.66% for the S&P 500. This year it’s shaping up to be more of the same since all the indicators in our short-term timing model are in the midst of rolling over and going negative from at/near oversold extremes.
The main driver in the markets remains the push by central banks to reduce inflationary risks and to begin to lower interest rates further to begin to spur on growth. We have seen some downward pressure, and Bank of Canada on Wednesday made a further 25 basis points cut. The big concern, both in Canada and the U.S., is the state of the job market and weak employment which can create a potential recessionary environment. The following is the full BMO Economics EconoFACTS: BoC Policy Announcement commentary:
The Bank of Canada cut its overnight target rate again by 25 bps to 4.25%, as widely expected. This marks the third cut in three consecutive meetings, and leaves the BoC as the top cutter among G10 central banks so far this cycle. With the rate decision itself of little surprise, the focus was mostly on the tone of the Statement, and while it was mostly bland and factual, there were a few dovish morsels.
Some key quotes that stood out (and they are all from the Governor's Opening Statement, which was richer in content):
" ...with inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much."
This comment followed some discussion about the risk that inflation could still bump back up later this year on less favourable base effects, but it reinforces the point that the Bank is growing increasingly concerned about the softness in the job market.
"The rise (in the unemployment rate) is concentrated in youth and newcomers to Canada, who are finding it more difficult to get a job. The slack in the labour market is expected to slow wage growth, which remains elevated relative to productivity." Persistent solid wage growth may be the single biggest factor keeping the Bank from being even more aggressive, as it is also playing a role in keeping some services inflation sticky.
"We are determined to get inflation down to the 2% target, and we want it to stay there. We care as much about inflation being below the target as we do above. The economy functions well when inflation is around 2%." Again, a hint that the Bank could get more aggressive on the rate-cut front if inflation slows faster than anticipated, although they have not been surprised by recent trends. As an aside, the recent big drop in oil and wholesale gasoline prices could lend a big assist in the inflation fight in coming months.
" Our July projection has growth strengthening further in the second half of this year. Recent indicators suggest there is some downside risk to this pickup." On the growth side, they readily recognize that their Q3 call of 2.8% GDP growth from July now looks a tad optimistic, only partly offset by slightly stronger growth in Q2.
Bottom Line: We expect the Bank to continue grinding down rates in coming meetings, and, while we anticipate a series of 25 bp steps into early next year, we certainly will not rule out a possible 50 bp step at some point. That's especially true if CPI behaves and/or the unemployment rate takes another big step up. And the reality is that the jobless figures have quickly become equally as important as the inflation data in the Bank's decision making. For now, we look for the Bank to cut rates to 3.5% by January, and then to 3.0% by next June, but the risks tilt to the Bank going faster than that, and potentially further.
In the U.S. we are seeing a similar situation with a cooling of the labour market there, and a contraction in the manufacturing sector. Their economy is slowing as well, and we will be watching the upcoming reports for signs the U.S is possibly on the brink of a recession. Either way, we are expecting further interest rates cuts in the U.S. The questions for investors, however, are -- will it be just a quarter point or a half percent and will there be more before the end of the year?
Given the recession fears and expectation for lower interest rates, the U.S. dollar has been declining versus most currencies of late, and that includes the Canadian Loonie. As of writing, even after this weeks’ drop in the interest rate in Canada on Wednesday, the loonie is holding near its “technical midline” of the past year due to the near certainty that the U.S. Fed will be dropping rates at least a quarter percent. We would, therefore, consider now a good opportunity for the snowbirds to be purchasing at least half of their USD that they may need for the coming winter. If the U.S. drops more than a quarter point at the next meeting on September 17-18th, we will see the USD weaken further, but currency game is always a very hard one to play. We recommend some or even all of purchases now while the Loonie is at the 0.74USD mark.
The ongoing, and terrible, war in the Ukraine vs Russia and the nasty exchanges in Israel vs Hamas (and other Iranian proxies) continue to create uncertainty, which leads to market volatility. But as we have discussed in the past, as long as those wars do not expand (for example that neither U.S. nor China put boots on the ground), then from an investment point of view, we do not expect any major effect with respect to portfolio management. We only continue to hope for some sort of resolution soon.
As the U.S. election nears, we expect it to create more volatility as both sides battle it out. From an investment point of view, we are agnostic to the winner as long as neither side obtains all three positions of the Presidency, the Senate, and the House. A split creates the balance of power necessary that markets prefer. While it limits what can actually get done by the governing party, the split also ensures that the party cannot do a lot of damage as they are offset by one of the other three.
As we get closer to the election, markets may begin to sigh a breath of relief simply because the long four-year cycle is coming to an end. We typically see a run up in the markets prior to the election for that very reason. Now, if the Democrats win, markets will be pleased, again simply because the process is done. Should the Republicans win, then markets may push a little higher as investors tend to see them as more business friendly with respect to lower taxes and less business regulations. This all assumes that both sides accept the results (which both have had issues with in the past twenty years).
We are in the Green Zone and again we remain invested with one foot on the gas with relatively stronger long-term positions, and the other on the brake looking for protection on the downside. We have increased exposure to the latter in the last few days in anticipation of the volatility expected through to mid-October. Any pullback is likely to be just that – a typical drawdown in the markets which come regularly, restoring health to overbought markets and creating new opportunities for us to enter when volatility settles down (again likely mid-October).
Should you have any questions regarding your own portfolios or if you are looking to update your personal financial, tax, or estate plans, we are always pleased to meet in person or via video or phone anytime.
Best regards,
John, Victor, and Megan