Riding the market’s roller coaster

Market Recap

• Equity markets were little changed this week, but it was quite a ride. The S&P 500 finished flat after sliding 4% early in the week, as a host of factors triggered a surge in volatility—some unwinding of the yen carry trade, U.S. election uncertainty, and valuation de-frothing in Tech.

• Banks and Energy held up best with solid gains on the week, while Materials, Utilities and Consumer Discretionary lagged.

• At one point, the VIX measure of implied volatility jumped above 38, not matching levels seen during history’s most infamous market events, but well worth noting in comparison to some serious past dislocations.

Equities

The last couple of weeks have been eventful for markets to say the least. After last Monday’s precipitous drop, markets were back-and-forth until Thursday, when stocks surged on data showing a decline in weekly U.S. jobless claims. This would seem to confirm the point I made last week, which is that the economy is likely not as bad as markets thought a week or 10 days ago. That said, there are still legitimate reasons for investors to be cautious. As we’ve highlighted previously, consumers are changing their spending patterns, and there is some softness in the job numbers. In short, after 18 months, we’re now seeing the impact of higher interest rates, and volatility is increasing as expected. It’s also important to note that prior to last Thursday, there were a couple of days when the market looked good but then fizzled out. That tells us there’s an undertone of nervousness in markets, and it’s hard to determine whether people are simply buying on the dips or if some investors who didn’t have a chance to sell off last week are now doing so whenever markets inch higher. Probably a bit of both. As a result, it remains unclear whether the worst is behind us or if there’s more selling to come.

Bottom Line: We expect to see more market volatility and conflicting economic data over the next few months.

Bonds

How have recent market events—and a potentially accelerated rate cut schedule for the U.S. Federal Reserve (Fed)—affected fixed income? Amid the recent turmoil, the market quickly priced in additional rate cuts, and the bond market did exceptionally well as a result. In our view, that brings us back to where we were at the beginning of the year, when markets were pricing in too many rate cuts and expected good bond returns only for rate cut projections to get pared back to only one or two for the year. It’s challenging to time this bond market because of how quickly it’s pricing in potential cuts. With the benefit of hindsight, the beginning of August was likely the right time to start moving money out of cash and into bonds, which is what we did in our portfolios. Since then, the environment has changed: the Bank of Canada (BoC) is expected to continue cutting while the Fed is almost certain to cut in September and not stop there, with three or four 25-bps decreases possible before year-end. In our opinion, an emergency rate cut or a 50-bps rate cut in September continue to be unlikely scenarios, as they would amount to an admission by the Fed that they got it wrong and could send the wrong message—one of panic—to markets.

Bottom Line: The bond market should benefit from more rate cuts by the Fed over the rest of 2024.

U.S. Election

While markets roiled, the race for the White House rolled on, as Democratic nominee Kamala Harris selected Minnesota Governor Tim Walz to be her running mate. Given Harris’ apparent momentum, investors should no longer be pricing in a slam dunk Donald Trump victory, which seemed likely if he had faced Joe Biden. What they should be pricing in is the very real possibility of Kamala winning, which could have ramifications for certain sectors. In our view, the selection of Walz as the Democrats’ VP candidate is supportive of Harris’ strategy and appeal to voters. One of the things her candidacy has done is return the race to a more typical Democrat vs. Republican contest—which one would expect to be close—rather than being focused around Biden’s age and therefore skewing towards the GOP. It’s hard to imagine how the Democrats could have played out this top-of-the-ticket switch any better. If Kamala had been selected as the candidate on day one, it’s entirely possible that her candidacy would feel routine by now rather than energizing for her supporters. Voters love momentum, and right now, it’s in Harris’ favour—but polls are close, and we still expect a tight race.

Bottom Line: If you were pricing in a Trump landslide, now is the time to think about what could happen if Kamala wins.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Politics and profits: Finding wins in an election year.