Hunting for clues in corporate earnings

Market Recap

• After closing off the month of April in the red, most equities rallied in the latter half of the week, helped by earnings reports (notably Apple), a less-hawkish-than-expected Fed, and some encouraging late-week data.

• The tech-heavy NASDAQ (+1.4% on the week) led gains among major indices, with the Dow (+1.1%) not far behind.

• On the other end, the TSX eked out a 0.1% loss. (Note many global markets were closed for at least one day this week, with China closed since Wednesday.)

Rate Expectations

Last week, U.S. Federal Reserve (Fed) Chairman Jerome Powell once again hinted at delaying the timing of rate cuts—yet no one was surprised. Market expectations have moved past June and July toward the fourth quarter, and only one to two rate cuts are now considered probable for the remainder of 2024. It was notable that Powell acknowledged that inflation has been stickier in recent months. However, what garnered less media attention was that he also highlighted the progress that’s been made on inflation. To us, this raises the question: if progress has occurred, why is the rate unmoved? We feel the answer is that a rate cut is forthcoming later in the year. Conversely, when asked about the prospect of increasing interest rates to combat the stubbornness of inflation, Powell said that a rate hike was “unlikely.” The lack of a definitive “no” gave some market participants pause, but we feel it was the correct appraisal of the situation. A rate hike, however improbable, is still a non-zero possibility in this environment and can’t be definitely ruled out. That said, we do not see it as likely.

Bottom Line: Despite Mr. Powell indicating a deferral of interest rate cuts, markets were mostly calm, showing that investor expectations have shifted to later in the year.

Bellwethers

Several corporate earnings have, in previous weeks, provided insight into the state of the consumer. It is important, though, to know which particular consumer segments they represent—Starbucks, for example, is the sort of business that figures into the daily spend of many consumers, yet its earnings miss this quarter does not necessarily mean people are closing their wallets. The company is an up-market brand within its segment, similar to what Lululemon represents within leisurewear. Consumers therefore have the option of adjusting their spending patterns to a more economical option—a less expensive coffee, in other words—before they make the decision to stop that daily purchase and instead make a cup at home. It also means less likely add-ons with high margins.

Apple, on the other hand, really surprised people with their earnings numbers, and two things stood out. First, they initiated the largest stock buyback in history. This can be taken either as them not seeing much opportunity to invest in growth, or them having confidence in their stock and feeling it is undervalued. Right now, I am leaning towards the former. Second, they delivered better-than-expected results out of China. This story is quite positive as it might mean the consumer is starting to spend again, which is very bullish sign not only for China, but also for the broader global economy. This is probably why Apple’s earnings pushed markets significantly higher at the end of last week and why many sectors participated in the rally.

Bottom Line: Although some brands have shown earnings weakness, Apple’s success highlights again that this is not the time to bet against equity markets.

Currencies

In recent weeks, we have witnessed spikes of volatility in the Japanese yen which appear to be driven by monetary policy. The Bank of Japan has, at long last, followed other central banks in raising interest rates away from the lower zero bound. This shift has naturally led to an increase in the value of the yen, because as yields rise, they tend to lift the value of their underlying currencies. We were not surprised by the movement—if anything, it was a delayed reaction. Closer to home, the Fed looks like it will be the last to cut behind the Bank of Canada and the European Central Bank, which will in effect keep the U.S. dollar (USD) in a dominant position for the rest of the year. The Canadian dollar (CAD) is likely to weaken on a relative basis, possibly even as low as $0.70, due to the higher likelihood that rates will come soon. We even saw the CAD drop by 30 to 40 basis points when the U.S. reported strong jobs numbers. However, we feel the loonie is unlikely to breach below $0.70, as there has often been a mental barrier about going into the sixty-cent range. In Europe, an economic rebound and real productivity gains could help the EUR-USD offset any negative impacts of a more aggressive rate-cutting timetable.

Bottom Line: The Fed will likely cut rates last, which is why we expect the USD to continue to be king.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Delayed Again: The Soft Landing that Never Comes.