Exploring ideas in earnings and emerging markets

Market Recap

• Markets continued their strong start to the year with inflation and growth both cooperating.

• The S&P 500 rose 1.1% as energy and telecom services rallied more than 4%, while consumer discretionary lagged. The index pushed further into record territory at one point, leaving it up more than 30% from the October 2022 low, a level that was set amid widespread expectation for a U.S. recession. The TSX added 1% on the week.

• With the advance Q4 growth numbers now in hand, the U.S. economy finished 2023 by reeling off a sixth consecutive quarter of growth at 2% or better, almost laughing off recession calls and over 500 bps of Fed tightening. While Q4’s upside surprise of 3.3% annualized rate was largely because of trade and inventories, final domestic demand continued to run at a solid 2.7% clip and is now up 3% in the past year.

Earnings

Earnings season is upon us again, and our expectation is that companies will be punished for bad performance and rewarded for good performance, which isn’t always the case. Last week, Tesla got hit hard after their earnings miss, while Nvidia reported positive news on orders and upside potential, causing their stock to surge past $600 per share. It’s a remarkable story given that at $450 some investors were already wondering whether all the good news had already priced in; clearly, it was not. As earnings announcements continue to roll out, investors will be looking at both the quarter-over-quarter numbers and the stories behind them to get a sense of whether the economy is weakening and, if so, how quickly—for now, consumers appear to still be spending. Going forward, we expect earnings to be more of a company-by-company story than a sector story. That said, we believe that Energy and Technology are likely best positioned to benefit from macroeconomic trends and report robust earnings.

Bottom Line: If companies deliver strong results in a gradually-weakening economic environment, they are likely to be rewarded by investors.

India

For the past few days, I’ve been travelling in India looking for opportunities, and during my time here, some interesting news broke: the Indian equity market overtook Hong Kong to become the fourth largest stock market in the world.¹ Should investors be weighting India more heavily in their Emerging Markets portfolios? Yes—at this stage, we think India may be an undervalued market. There are two sides of the coin here: pessimism around China and optimism around India. For China—and, by extension, Hong Kong’s equity market—the negativity is largely baked in at this point, though various risks remain, including a weak property sector and tensions with Taiwan. By contrast, India has a growing economy and the world’s largest population, including a growing middle class. Political continuity is also likely, which means that Foreign Direct Investment can trust that the regulatory and political environment is unlikely to change dramatically. Here on the ground, positive signs are everywhere—for instance, new infrastructure like bridges and better roads means that people will spend less time stuck in traffic, potentially improving productivity while giving consumers more time to go out and spend. During my visit, I’ve also had a chance to speak with representatives from the president’s office as well as Mumbai’s business community, and they’re similarly bullish on consumer spending.

Bottom Line: As India’s middle class grows, so will their discretionary spending, which is a good sign for the future of the Indian economy.

Interest Rates

Last week, the European Central Bank (ECB) joined other central banks in holding policy steady rather can cutting interest rates. Are markets getting the message, or will they still be surprised if rate cuts don’t come soon? In our view, investors have a form of selective amnesia—they get the message on the day but then quickly forget, reverting to more optimistic expectations. As part of their announcement, the ECB said they’d likely begin lowering rates in the summer. Like the U.S. Federal Reserve (Fed), it’s no so much a question of if the ECB is going to cut, but when. The Fed has held back on establishing a firm timeline—they continually remind markets that they’re data-dependent and will make the move whenever the economy justifies it. For now, the economic numbers continue to signal resilience. The Bank of Canada (BoC), for their part, seem to be taking a more hawkish stance than one might expect given the weakness and indebtedness of Canadian consumers. In our view, they have the strongest reason to cut rates of all the major central banks but have apparently decided to hold back. No one at the BoC or other central banks wants to make a policy mistake, and sometimes, there’s comfort in numbers.

Bottom Line: The BoC doesn’t need to wait for the Fed to cut rates, but it’s possible they will.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Cracking the Fed’s Code.

BMO GAM’s 2024 Market Outlook

In this one-hour video, I’m joined by six portfolio managers—specializing in Bonds, Dividends, Healthcare, Real Estate, Financials, and Technology—to share what could be in store for markets in the year ahead, including potential risks and opportunities.