Strait-Forward?
While the start of the spring season has been wet and chilly, the financial markets have long since thawed from the effects of the conflict in the Middle East. Despite the geopolitical back-and-forth since the start of the calendar year, April proved to be an incredibly resilient month. The Dow Jones and the S&P500 rose approximately 7.0% and 10.4% respectively, while the tech-focused Nasdaq surged up 15.3%, primarily driven by the recovery in semiconductors and artificial intelligence. The TSX also saw a 3.0% increase for the month but lagged behind US markets due to the underperformance of energy.[1]
We are, as well, appropriately entrenched in the Green Zone across our longer-term indicators. While we did pivot to defence in March – we rotated out
of our overweight in technology and into energy, consumer staples, gold, short term government bonds and cash – we have since redeployed any funds on the sidelines back into the markets based on our technical signals, and are once again overweight in technology and geographically, the US.
The resilience of the global markets cannot be overstated –they have been fundamentally strong heading into the US-Iran conflict and remain so despite a resolution. Brent Joyce, BMO’s Chief Investment Strategist, wrote last month:
“The global economy is buoyed by many factors: reasonable levels of inflation; supportive financial conditions; decreased trade uncertainty; productivity gains; fiscal stimulus, including tax cuts; capital expenditures in AI, defence and infrastructure; deregulation; and signs that employment, manufacturing and housing activity are attempting to exit their recent soft patch. These underlying constructive fundamentals and the resulting upgrades to corporate earnings outlooks drove most global equity markets upward through February.”
April marked the start of Q1 earnings reporting and the first real “test” of the fundamentals. Safe to say, US markets passed with flying colours. Carol Shleif, BMO’s Chief Market Strategist, summarized:
“Solid earnings results at the start of the Q1 reporting season buttressed the more optimistic bias of stock investors. In the U.S., 63% of companies – including six of the Mag 7 names (Tesla, Apple, Amazon, Meta, Google and Microsoft) – have released their numbers. Aggregate sales growth is 11% while earnings advanced over 28%. The participation is spread broadly: eight of 11 sectors reported bottom-line growth of 10% or more. The better news is coming not only from tech but also from materials, industrials, and financials. Key themes there include resilient consumer spending; hearty capital markets activity (mergers and acquisitions, trading and debt issuance); growing backlogs and deliveries for key industrial and transportation companies; and better volumes for purveyors of consumer goods.”
While our investment strategy focuses less on fundamentals and more on technical analysis, both schools of thought are seemingly aligned. All major indices are above every key moving average, from 5-day to 200-day. This tells us that everything is in an established uptrend, and there are no trend cracks at the moment. More importantly, the strength is not isolated -- large caps, mid caps, and small caps are all moving higher together, which is indicative of overall support and momentum. Bulls can stay bullish longer than bears can stay bearish, and right now the bulls are in full control.
Abated Breath:
While we’ve maintained a cautiously optimistic tone all year, it does not detract from the fact that the longer it takes the US and Iran to reach a resolution, the larger the economic impact will be on global markets. Brent Joyce, Chief Investment Strategist, continues in his commentary:
“The Middle East conflict is a risk-off event that stokes fears of stagflation (inflation and slow/no economic growth), a scenario where oil prices and bond yields rise and the U.S dollar strengthens.”
A lot has been said already about the physical supply of oil, which continues to be a problem for Europe, Japan and China. Short-term reserves and other workarounds (Trump heavily petitioning the US as a provider) are currently buying some time, but the more this conflict drags on, the more these reserves are depleted, and the more damage is done to the infrastructural around the Gulf. The main concern here is that even if the Strait is reopened tomorrow, the logistics will not allow for the supply to return to its pre-conflict levels for some time. Higher energy costs and other input costs have the potential to bleed into the global economic backdrop, causing inflationary issues that could extend past what is considered to be “transitory”.
The good news is that the conflict remains regional, and while the US has conducted targeted airstrikes and sent its Navy, further escalation has not yet occurred. Investor sentiment has seemingly certainly taken its position that things will be sorted out sooner or later, and there may be some truth to that given how the markets have decided to move on.
Jennifer Lee, BMO’s Senior Economist, reported on Wednesday this week:
“What exactly is sparking this global rally in financial markets this morning? Was it President Trump citing ‘progress’ in Iran’s revised offer behind his decision to put Project Freedom on ‘pause for a short period of time’? (And Pakistan and other countries requested it.) Was it the Axios’ headline: ‘U.S. and Iran closing in on one-page memo to end war’, accompanied by the following text: ‘The White House believes it’s getting close to an agreement with Iran on a one-page memorandum of understanding to end the war and set a framework for more detailed nuclear negotiations, according to two U.S. officials and two other sources briefed on the issue…the U.S. proposal has a full nuclear deal with Iran to be negotiated later.”
Area of Interest:
As we alluded to, one area we are watching closely for is the severity of the economic damage done from the closure of the Strait of Hormuz. Prior to the conflict, both the US and Canada were in decreasing interest rate environments, and equity markets had priced in that tailwind. However, if the closure causes stickier-than-expected inflation, both central banks may have to look at reversing course and tightening monetary policy. While the US has shown moderate economic growth that could sustain potential interest rate increases (at least temporarily), the same cannot be said for Canada. We have a much weaker economic landscape, and stagnant growth coupled with high inflation will lead to stagflation, creating a lose-lose dilemma for the Bank of Canada. Historically, stagflationary periods create a difficult environment for financial markets thrive in, and it is something that we are continuously monitoring.
Bottom Line:
While the news cycle is all doom and gloom, we continue to preach cautious optimism for the rest of the year. We are fully invested and in the Green Zone as of writing, and the equity portion of our portfolios continue to perform well despite a myriad of geopolitical and economic concerns. We are watching our lines intently and are fully prepared to move to the defensive should there be signs of weakness again, but for now, the markets are telling us to defy the wall of worry.
As Carol Schleif, Chief Market Strategist, aptly concludes:
“New highs tend to beget new highs – provided fundamentals and valuations remain directionally appropriate. While valuations are full, market choppiness (especially through the first three months, including a near 10% pullback and significant corrections in individual stocks and sectors) and double-digit earnings increases are helping share prices grow into valuations.”
As always, should you have any questions regarding your portfolios or planning, or if you would like to meet in person or by phone or video conference, we are pleased and ready to do so.
Regards,
John, Victor and Megan
[1] Sources: investing.com