CIO STRATEGY NOTE
Surprise, surprise: A U.S. job market that simply won’t quit
The U.S. Federal Reserve (Fed) recently went forward with a 50-basis point rate cut, giving markets a clear signal that the central bank believes inflation is coming under control. However, the trajectory of future rate cuts may now be impacted by another factor—an unusually strong U.S. economy. The macro picture has continued to look robust now into October, with both consumer and corporate data showing resilience against the monetary tightness that was intended to slow down growth. In fact, U.S. payroll data showed employers added 254,000 jobs in the previous month, far exceeding expectations and resulting in a downward dip in the unemployment rate.
Also, as an unexpected bonus, China’s latest round of stimulus provides an extra tailwind for world markets, though it may not be enough to change the country’s outlook in the long run. Domestic issues such as excess household leverage and a fragile housing market are structural challenges that will inevitably loom over China’s future if left unchecked. That being said, the short-term fiscal program was well received by investors.
We see markets continuing to go higher from here and, as such, have increased our Equity position
With more rate cuts ahead in most geographies and consumers in the largest economy still spending, our quarterly outlook remains constructive. We see markets continuing to go higher from here and, as such, have increased our Equity position. In terms of risks, the key things to keep an eye on are the upcoming elections, whether expectations are too high, and of course potential escalation in the Iran-Israel conflict—all of which could unleash greater uncertainty and instability on global markets.
Director, Multi-Asset Solutions
ECONOMIC OUTLOOK
What slowdown?
A red-hot job print, robust household spending and strong overall economic growth should put to rest fears of the U.S. economy tilting into recession in the near term.
U.S. outlook
Much of the focus in recent months has been on downward U.S. revisions, mainly related to the labour market, which foreshadowed a potential slide into a not-so-soft landing, according to some. Alas, we have been surprisingly subjected to the opposite in recent weeks, with upward revisions to household consumption and overall economic growth—projected to remain at about a 3.0% year-on-year pace—reinforcing confidence in the view that the glidepath for the economy appears far from taking a nasty turn downward. U.S. consumers have benefitted from a sustained downdraught in gasoline prices, effectively handing them a “tax cut” that has increased disposable income. Corporate earnings as a share of gross domestic product (GDP) meanwhile are also moving higher—indicative of a stronger-than-expected corporate sector (see chart). To be sure, employment is the primary driver of sentiment and more importantly, monetary policy. A September print that revealed a far better-than-expected 254,000 jobs added underscores our view that this is an economy still exhibiting clear momentum, and thus, may slow the U.S. Federal Reserve’s easing pace to 25 bps intervals. We are still looking at a total 100 bps of cuts through the end of the year. Yet, if anything, the likelihood of a Fed pause is now perhaps in view if employment can hold above 200,000 job gains per month.
U.S. share of corporate profits: Before and after GDP revisions
Source: BMO Global Asset Management.
Canada outlook
We are seeing some generally positive news out of Canada as well, insofar as the country’s dour economic state will allow. Although overall growth is running below potential—and at about half that of U.S. GDP—an annualized expansion of between 1.0-1.5% for Q3 is of course well above recessionary levels. Skeptics will point out that inflation is racing lower at a faster-than-expected pace, and with the latest Statistics Canada prints hinting at the potential for further economic slack to come, there is very much a case for a stickier dovish stance from the Bank of Canada (BoC) compared to the Fed. The domestic Consumer Price Index (CPI) has fallen back to target (2%), while unemployment sits well over 6% amid weakness in private sector full-time positions. With a firm grip over consumer prices amid a softened economic and labour backdrop, real GDP could very much use a shot in the arm from policymakers to limit further downside risks. The odds of a more aggressive BoC to undertake outsized cuts for the rest of the year are growing.
International outlook
Outside of North America, the economic focus is on China. Beijing has pulled out the proverbial bazooka to detonate an entrenched malaise from a property market meltdown that has spilled over into many other facets of the economy. Several measures, including direct Equity purchases to boost valuations (and confidence), aim to lift the world’s second largest economy from its doldrums. We also anticipate more to come, mainly in the form of a significant sum directly injected into households via ‘helicopter’ money (i.e., cash sent directly to consumers). It may not be enough to negate China’s long-term stagnation challenges, but does represent a quick fix for domestic woes.
Key risks | BMO GAM house view |
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Recession |
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Inflation |
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Interest rates |
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Consumer |
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Housing |
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Geopolitics |
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Energy |
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Director, Portfolio Manager
PORTFOLIO POSITIONING
Asset classes
We’re leaning into Equities while tilting back from bonds as broader stock market participation remains relatively sturdy and there’s some profits to be taken from the rally in Fixed Income.
Rate-sensitive sectors are still in relative rally mode, boosting overall market participation and leading us to move our score to +1 on Equities (slightly bullish). There has certainly been a notable change in sentiment, driven first by the Fed’s front-loaded 50 bps cut of this cycle. That has helped U.S. Equities (and to a degree Canadian, as well). Yet in addition, we’ve seen some knock-on effects from China’s massive stimulus package. Commodities have driven higher, lifting Emerging Market indices (and to a degree Canadian materials, as well). The broader participation as noted last month is an added comfort to our call, with sectors that will benefit from lower rates –i.e. Financials and Utilities—assuming some market leadership, which is welcome news for risk assets. There are counterweights to these positive developments though: 1) seasonality is a headwind historically in early autumn (a period when volatility typically picks up), and 2) like any rally, things can run too far, too fast. While the team’s consensus view is more positive this month, we are certainly not prepared to completely abandon our protective diversification and hedges that have been put in place. When the tightrope you’re walking rises, it’s prudent to raise the safety net, too, even if it costs you a few basis points of alpha1—especially so amid a volatile U.S. election cycle and rising geopolitical tensions.
We’ve tempered our view on bonds, moving back to neutral (0) from a score of +1 last month. Fixed Income has become a crowded position, with investor behavioural dynamics over the past few months not dissimilar from children in a candy store. We’re content to take some money off the table at present levels.
EQUITIES
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
FIXED INCOME
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
CASH
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Vvery bullish
Head of Multi-Asset Solutions
PORTFOLIO POSITIONING
Equity
An oversized rate cut and big deficit spending amid above-trend growth. Indeed, U.S. Equities are enjoying an unrivalled mix of supports. China has introduced its own stimulus, but it’s a distant second.
We are starting to see some other regions play catch-up to the U.S. market in terms of returns but that development has been more of a sector-by-sector story rather than broad-based theme fueled by non-U.S. economic expansion. This dynamic is visible via the quarterly sectoral returns data, which shows Info Tech and Communications Services—mega-heavyweights in the U.S. market—tumbling to near-bottom last quarter. But make no mistake, we are still biased toward a U.S. equity market that has just received an oversized interest rate cut with more to come amid massive government fiscal spending—and backed by an economy tracking close to 3% in Q3. The rest of the world remains a distant second. For now, the Fed rate cuts serve mostly to boost confidence but they will have a real effect on the economy next year as more cuts are realized.
In Canada, the economy remains stuck in low gear while an easing monetary cycle may simply serve to stave off downside surprises rather that spur something akin to robust growth. With that said, we have seen a positive bounce in the domestic Equity market driven by upside economic surprises. However, we aren’t extrapolating those positives too much into the future while our base case is for the TSX to continue its underperformance against U.S. indexes. Canadian rate-sensitive sectors have experienced a nice run, but we have turned less bullish in line with us becoming more neutral on Fixed Income.
We remain neutral on Europe, Australasia, Far East (EAFE) (0), with markets relatively stagnant, though we don’t see the outlook worsening much from here. The bigger focus now is Emerging Markets (EM) and Chinese Equities. While the economic impact is potentially material, it is less clear how much of a pass through we’ll see into earnings. We do believe price-to-earnings (P/E) multiples2 will get a short-term boost from a pick-up in confidence, but we remain neutral (0) until we see more evidence of structural reform.
CANADA
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
U.S.A.
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
EAFE
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
EM
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
Head of Multi-Asset Solutions
PORTFOLIO POSITIONING
Fixed Income
Rates have moved fairly far, fairly fast in the past quarter, prompting us to take some money off the table from Fixed Income positions. Within the asset class, inflation-linked and longer-dated bonds are still favoured.
The 50-bps policy reduction from the Fed in September could be taken as an admission it was wrong to wait until now to commence the easing cycle but should not be construed as a panicked response to catch up. From a portfolio perspective, bond markets are signaling the move increases the probability of an economic soft landing, which should have the effect of boosting Equities and adversely impacting bond prices. Hence, our re-rating on bonds broadly to neutral (0). It is an opportune time to take some profits given rates have moved quite a bit over the last quarter. However, within Fixed Income we maintain our preference for Duration3 as longer-dated bonds have historically continued to benefit beyond the first rate cut. In addition, we are seeing the resumption of the long-term negative correlation between stocks and bonds. In that context, Duration is now a good Equity hedge. Any softening in Canadian or U.S. employment should boost the demand for bonds.
Our lone Fixed Income score change on the month is a downgrading of Investment Grade (IG) Credit to neutral (0) from a +1. Spreads remain very tight so we prefer government bonds which are more of a pure play on Duration. Additionally, we have added exposure to real rates through inflation-linked bonds, including Real Return Bonds in Canada, and U.S. Treasury Inflation-Protected Securities (TIPS). Breakevens in the U.S. 10-year bond reached 2% for the first time in several year, underscoring our current view.
IG CREDIT
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
HIGH YIELD
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
EM DEBT
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
DURATION
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
Director, Portfolio Manager
PORTFOLIO POSITIONING
Sector & factor (tactical)
Individual Technology names appear pricey, but as ever, are expected to lead earnings growth through Q3. Looking further out, the market appears dismissive of tailrisks at its peril.
Value stocks have managed to close some of the gap between them and Technology but the relatively easy gains are now in, thus, we’ve taken the factor’s score back to slightly bullish (+1) from outright bullish (+2) this month. Given our tactical beta4 implementation vehicles, we still remain underweight tech, but where there are dedicated exposures, we are increasing options-based protection around holdings. In a broad sense, staying invested in Technology, Info Tech and adjacent sectors over the long run is critical for long-term success, but several individual names are certainly showing as pricey at current levels. Conversely, on an equal-weight sector index basis, some very good companies are showing reasonable valuations—a boon particularly to active managers. Market cap-weighted ETFs may lag in the near term as those pricier names that have outperformed year-to-date take a breather, though we still expect earnings outperformance to persist—Technology and Communications Services are expected to lead profit growth, with consensus estimate of 14.6% and 12%,5 respectively. In contrast, many other sector estimates are trending down, led by Energy’s 20-plus decline in expected profit year on year.
Looking beyond the present (into Q4 and the first quarter of the new year) there are increasing tailrisks around the U.S. election and geopolitical tensions in the Middle East. Yet somewhat confusingly, we have seen virtually no movement in earnings projections—the market seemingly negating those risks while also contradicting the notion that the economy has cooled sufficiently to allow the Fed to keep cutting rates. All told, the market may be setting up for potential disappointments, either when earnings are reported, or when sell side analysts sharpen their pencils (read: estimates) between now and then.
VALUE
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
QUALITY
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
VOLATILITY
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
SIZE
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
Director, Portfolio Manager
PORTFOLIO POSITIONING
Implementation
Our view on the Canadian dollar (CAD) is not changed by a few so-so supports. Gold is taking a breather, but we are believers long term. The cost of Equity hedging has climbed, but it’s worth the price.
We have seen minor supports for the CAD (Fed cut, climbing Canadian savings rates, mildly better economic data), but nothing material enough to reset our slightly bearish (-1) view on the CAD. Meanwhile, Gold is definitely taking a breather after sailing past US$2,600/ounce. We continue to see a new high made at the $2,700 level as uncertainty climbs ahead of the U.S. election as well as around international military confrontations. However, we have bought some protective puts to provide some insurance on existing gains (again, sacrificing some basis points to raise the safety net). We are still believers in Gold long term.
On Equity hedging, the cost of downside protection versus buying some upside has climbed sharply. That said, we are looking for opportunities to add to risk headed into Q4—historically the time of year that has generated the best returns.
CAD
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
GOLD
- Very bearish
- Bearish
- Slightly bearish
- Neutral
- Slightly bullish
- Bullish
- Very bullish
Footnotes
1 Alpha: A measure of performance often considered the active return on an investment. It gauges the performance of an investment against a market index or benchmark which is considered to represent the market’s movement as a whole. The excess return of an investment relative to the return of a benchmark index is the investment’s alpha.↩
2 The price-to-earnings ratio (P/E) is one tool to determine the relative cheapness or expensiveness of a stock. It links the market value of a company to the profits it generates. P/E ratios are calculated as the ratio of today’s stock price divided by twelve-months’ earnings per share.↩
3 Duration: A measure of the sensitivity of the price of a Fixed Income investment to a change in interest rates. Duration is expressed as number of years. The price of a bond with a longer duration would be expected to rise (fall) more than the price of a bond with lower duration when interest rates fall (rise).↩
4 Beta: A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.↩
5 Bloomberg/BMO Global Asset Management.↩
Disclosures
The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent prospectus.
This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.
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