The market advance over the past year has truly turned a lot of heads, in a good way. After the initial bear and bounce triggered by the Covid-19 pandemic, markets went on a phenomenal run. The rollout of vaccines driving the re-opening trend in the economy helped, as did the continued emergency monetary and fiscal support policies. And what a run. During this advance, consumer spending pivoted much more to durables such as vehicles, homes, and technology.
In this months Investor Strategy we dive into the current period of market weakness as we continue to believe the next few months will prove challenging and could even include a good old fashion correction (that is a drop more than the 4% investors have become accustom). The good news is the Market Cycle indicators remain healthy implying this isn’t the start of something worse. Plus some new content on market internals from breadth to sentiment.
With Q3 earnings season set to start in a few weeks, this season may prove especially challenging. The past few earnings seasons have been dominated by an historically high trend of positive surprises from companies, including earnings to revenue. This has helped markets move higher. However, this season companies are struggling with continued supply chain issues and rising cost pressures. So far a few key companies have already warned about their upcoming results. Earnings revisions have already started to come down, more so in some sectors vs others, potentially highlighting sectors at greater risk. This may prove a tougher earnings season compared to the past year.
This week’s Weekly Insights is on inflation as we are starting to see some of the transitory components begin their descent back to earth. Used car prices and airline tickets can’t go up 10% a month for long. While not a surprise, attention should increasingly be focused on the non-transitory components of inflation that are showing some signs of stirring. We believe inflation comes back down as temporary supply bottlenecks/demand spikes normalize. Afterwards, the base rate will likely be higher than the past decade, putting some upward pressure on yields.
Modern Portfolio Theory (MPT) sits at the core of just about every portfolio construction process. While developed some seventy years ago, the core beliefs of MPT remain as applicable today as they did before. Combining various asset classes that have different return and volatility characteristics, a portfolio can be constructed to target an expected return given an appropriate level of risk (volatility). More recently, say the last 25 years, this approach has been at the core of proportionately combining equities and bonds to achieve different portfolios to suit various investor needs and objectives. And to put it frankly, this has worked very well helping many investors reach their goals.
The equity markets did not disappoint as the summer months have now come and gone. Historically, a term that is used frequently throughout the season is ‘Summer Doldrums’. Safe to say the doldrums were nowhere to be found in the year 2021. Particularly in the U.S., markets continued their outperformance on the backs of dovish Fed policy. The S&P 500 climbed +2.9% in CAD terms duringthe month of August, while the Nasdaq jumped a whopping +4.0% (CAD) in the final month of summer. Investors must be getting more intelligent, as every time there is a dip down to prices seen one or two months ago, the market comes roaring back. Say it with me, “BUY THE DIP!”. There, now we can all call ourselves members of the self-proclaimed ‘Reddit Army’.
Uncertainty is the bane of the markets and we have experienced a higher than normal dose over the past few years. The greatest level of uncertainly was clearly during the early days of the pandemic when nobody knew anything about how things would unfold. As uncertainty declined, markets rose … quickly. The markets have clearly enjoyed 2021, with vaccine rollouts, re-opening trends and economic recovery driving earnings growth, plus continued monetary + fiscal stimulus. The S&P and TSX are up about 20% since January 1, with similar numbers out of Europe.
Investing is all about trying to figure out what is likely going to happen next. While a daunting task, sometimes what happens next is a bit easier to see. In this case, retail sales have exploded to unseen levels thanks to stimulus and changed behaviours during the pandemic. As stimulus begins to fade and the re-opening continues, this may reverse leaving, posing a threat to sectors that have been riding high on consumers spend behaviour.
Fluctuating oil prices is nothing new. We’re no longer surprised to see crude move +/- 4% in a day depending on the news, whether it be a production accident, an OPEC meeting or rising case counts. Most recently, oil has been under pressure on rising concerns over the demand impact of the next wave of infections. The contagious delta variant is already triggering renewed lockdowns in parts of China and other Asian countries where vaccination rates are low. This is a global concern, but we continue to believe that this remains a passing demand headwind, which can be offset by existing supply tailwinds.