BMO ETF Portfolios’ October commentary: “Markets Rocking, Despite a Hurricane”

Steven Shepherd, CFA

Director, Portfolio Manager

Commentary

Portfolio activity

On the options side, we bought protection for our gold bullion exposure via put options, given current extreme overbought conditions. While we are still bullish long-term, a period of consolidation may be on deck. Upside risk however remains in the event of a Trump victory in the U.S. Presidential Race, as estimates of a significant deficit increase may prove a headwind for the U.S. dollar (benefitting gold, as it is priced in USD). We also tightened up the strikes on our put spread on the S&P500, reflecting the gains made year-to-date, and broad upgrades in street estimates for year-end index levels.
We have narrowed our relative underweight of Canadian equities versus U.S., reflecting more positive views of the Banking sector, as well as the widened scope for the Bank of Canada to continue cutting rates without getting too far ahead of their U.S. counterparts. Gold has also been a key driver of index performance, which we have captured via our direct allocation, effectively bringing us to a neutral position across developed regions.
We took profits in our position of iShares 20+ Year Treasury Bond ETF (TLT) calls shortly after the U.S. Federal Reserve Board rate cut, selling roughly half of the December contracts held. Following the initial 50 basis point (bp) cuts, market yields reacted quickly and sharply, with market expectations quickly pricing in additional 50 bp cuts, which we thought too aggressive, a view ultimately proven correct by the September non-farm jobs report.
In the BMO ETF Portfolios, we made an additional allocation to our holdings of the BMO Carlyle Private Equity Strategies Fund. An evergreen fund (ie: capital goes to work immediately versus traditional delayed capital calls), focused primarily on secondary opportunities (ie, companies that have be previously owned by other private equity funds and have grown beyond their scope, or are being sold to provide liquidity to the selling fund’s earlier investors), this addition not only provides diversification beyond public markets, but provides holders of the Portfolios with access to private companies with higher growth potential than broad large cap indices.

“Markets rocking, despite a hurricane”

The fourth quarter is starting with a bang…several, in fact. Some good, some awful. The long-awaited September U.S. Federal Reserve Board (“Fed”) cut did not disappoint, with 50 basis points (bps) of encouragement for risk assets, sending equities higher, and bonds especially so.

September markets saw equities rise in most markets, lead by the MSCI Emerging Markets Index, up 6.8%, driven largely by the surge in Chinese equities, as the MSCI China posted a staggering 24.8% gain over the month, most of which came in the final five trading days. The S&P/TSX Composite Index and S&P500 Index returned an identical 4.2%, while the MSCI EAFE Index lagged with a less impressive 0.8% (all returns in local currency).

In the U.S., the Magnificent 7 (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla) once again dominated the U.S. market, with Tesla, Nvidia and Meta all rising. As a result, the sectors in which each constituent resides outperformed the broad benchmark (Discretionary, InfoTech, Communications), but notably, so too did Utilities and Industrials. Healthcare and Energy were net detractors, falling 1.6% and 0.4%, respectively.

A world away, the long-suffering Chinese stock market was jumpstarted by government overtures of a flood of monetary stimulus to combat lagging home prices, weak consumer demand, and falling trade volumes. The measures included a rate cut, reduced bank reserve ratios, lower borrowing costs on mortgages, looser rules on second home purchases, and roughly 800 billion yuan ($113 billion USD) of liquidity support for the domestic stock market (Bloomberg, 2024). The result was a surge in the MSCI China Index, with a cliffhanger over a week-long holiday for the market. The party stopped abruptly without additional announcements of further stimulus upon markets’ reopening, but to be fair, it was only the first day back after a week off.

The only issue with all these liquidity measures is that much like changing the oil on a seized engine, you need to crank it a few times to get the oil through the gears before starting it. More specifically, fiscal packages may also be needed to truly put China back on a stable upward trajectory, given challenges of an aging demographic, ongoing deflationary pressures, and tighter federal scrutiny of local government bond issuance. Back to the analogy, if the oil has nowhere to go, adding more just spills it all over the place, creating a hazard for a slip, or worse, a fire. In the Chinese economy’s case, the accident could be a surge in inflation without a corresponding increase in growth.

The September U.S. Non-Farm Payroll report exploded well past expectations, delivering 254,000 new jobs versus the consensus 150,000, which lowered the unemployment rate to 4.1% (U.S. Bureau of Labour Statistics, October 2024). Significant gains were made versus their 12 month averages in both the Services and Healthcare sectors. Bond markets quickly repriced expectations of another 50 bp cut from the Fed, pushing rates higher, and consensus implied cuts to only 25 at each of the November and December meetings left in 2024. Benchmark U.S. 10-year Treasury yields pushed back above 4%, as did the 2-year, before easing back to the high 3’s. It should be noted that Hurricane Francine made landfall mid-month, although was not seen to have impacted reporting significantly.

While not part of the core inflation calculations, it would be silly to ignore the impact of the surge in oil prices on headline inflation. With the escalation of the conflict in the middle east spreading to Lebanon and Iran, global energy prices have moved upwards, with Brent crude surging above $80 USD/barrel, a level last seen in August. In the U.S., West Texas Intermediate (WTI) tracked a similar pattern, approaching $78, and further shadowed by potential weather-related impacts on refining capacity in the gulf. Headed into the U.S. election, gasoline prices remain on a downward trend, with the average U.S. price per gallon down to $3.61 from April’s 2024 peak of $4.07 (Bloomberg, 2024). Historically, this has been a positive for an incumbent party, as it has also meant an incumbent president…he’s not running again, so it may be less important than prior years.

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