Reddit goes public: A good omen for the IPO market?

Market recap

• Equity market rose this week with a combination of sturdy economic data and no major hawkish surprises by the Federal Reserve.

• The S&P 500 rose 2.3%, led by banks and telecom services, while another hot IPO (Reddit) shot out of the gates.

• The TSX added 0.6%, touching a new record high at one point, led by Healthcare but held back by weakness in Consumer Staples and telecom.

The Fed

Last week, as widely expected, the U.S. Federal Reserve (Fed) held interest rates steady. The bigger story, however, was the market’s reaction—stocks surged because the Fed’s “dot plot” (which showcases the interest rate trajectory) still projected three interest rate cuts before the end of the year. It was a close call between two or three—if even one member of the Federal Open Market Committee had changed their vote, the projection would have been two—but this was nonetheless taken as a bullish sign by markets. The other part of the equation is that while the Fed revised its inflation and gross domestic product (GDP) estimates slightly upward and their unemployment estimates slightly downward, the moves likely weren’t significant enough to delay interest rate cuts even further. That’s why the market reacted so positively despite economic data that was a little hotter than expected. In essence, the market is perceiving that even in a good economy the Fed will stick to their plan in cutting rates. Taking a step back—were the Fed’s comments actually as dovish as markets thought? We think there was an undertone of hawkishness in the “dot plot,” as some dovish Fed members revised their interest rate expectations higher while the more hawkish members didn’t revise their estimates lower. Actually, 7 of the 19 members increased their forecast by at least 25 bps. Furthermore, the 2025 and 2026 rate expectations were moved slightly higher. That said, this subtle shift likely wasn’t enough to rock the boat. Fed Chairman Jerome Powell did mention that it was good that the Fed didn’t cut rates in December when inflations numbers looked promising, because things weren’t as promising in January and February. That suggests he still needs to see distinctly better inflation numbers before pulling the trigger on the first rate cut. Overall, these developments validate our thesis—we continue to believe that the consumer is stronger than most people were expecting, which is why we went overweight equities, and the Fed’s comments confirm that that was the correct decision. The fact that equities have run up doesn’t mean they can’t go even higher from here.

Bottom Line: We continue to expect two to three interest rate cuts in 2024—it’s the timing of those cuts that remains an open question.

Non-tech stocks

The “Magnificent Seven”—Apple, Alphabet (Google), Microsoft, Amazon, Meta (Facebook), Tesla, and Nvidia—have been the biggest story in equity markets over the past year, though a few of them have dropped off more recently. But given their market dominance, its understandable if some investors may look to diversify to other names or industries. First, it’s worth repeating: you don’t want to throw away the Magnificent Seven altogether. We don’t necessarily believe in all of them equally, but there’s at least a subset of the group that you still want to own. Nvidia is a great example, as its earnings have consistently beaten expectations and it is closely tied to the key theme of artificial intelligence (A.I.). That said, we do think it makes sense to diversity into other areas of the market, because we’re entering a new environment—we’ve already likely reached the end of the rate hike cycle, and once inflation comes down further and rate cuts begin, market conditions will be even more favourable for those names that underperformed in the higher rate environment. One sector we like is Financials—it’s been doing quite well across the board. In Canada, the “Big Six” are all high-quality holdings, while in the U.S. our preference is for the top-tier stable banks rather than regional firms, and there are lot of great international names in that space as well. Increasing loan loss provisions has been a concern, but if the economy holds up relatively well, that should prevent major job losses, which would ease some of that pressure. Aside from Financials, we also see Heathcare, Technology, and Gold as areas that are poised to do well. However, we still remain with a quality bias in the portfolios.

Bottom Line: We continue to like some of the Magnificent Seven names, but as the market environment improves, we have been looking out for attractive opportunities in other areas.

IPOs

It’s no secret that 2023 was a down year for initial public offerings (IPOs)—last year’s 171 IPOs globally was a modest decline from the 218 IPOs in 2022, which was a steep tumble from the 1,090 IPOs in 2021.¹ Last week’s IPO from social media platform Reddit was one of the biggest public offerings in a while, and it appeared to be a resounding success, with shares spiking 48% in their first day of trading. In our view, this interest highlights the fact that the market environment is better than most observers were expecting. If you’re a company that’s tied into one of the major market themes, like A.I. and digitization, it possibly makes sense to pursue an IPO in this environment—and if you aren’t, it doesn’t. Last year, most analysts had expected the consumer to weaken more than they actually did, which made IPOs an unattractive prospect, especially with cash and GICs offering unusually robust returns. Now, with interest rates likely to come down, the environment may be more supportive of valuations, as Reddit’s massive debut demonstrated.

Bottom Line: Social media is still a strong force in markets, and with the market environment improving, an IPO like Reddit’s makes more sense now that it would have one year ago.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled The Bulls Keep Running: Why Markets Remain Upbeat.