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As always, the market will “do what makes the most people wrong.” Looking back at strategy reports from a few months ago, the consensus for the year was notably muted. Most had been expecting single-digit equity returns and a more cautious economic outlook. The big theme in the bond market centred around rate cuts – expecting six – and predicting that yields would fall dramatically.
Yet here we are in April, and the bond market has adjusted down its expectations, pricing in two to three rate cuts. Bond yields are now at higher levels than when we started the year. If you had given someone those two pieces of data and asked them to make a bet on the equity market, most would have been very defensive, and maybe a few would have shorted some of the more speculative parts of the market. After all, for the last few years, the direction of yields has set the tone for equities, with higher yields acting as a drag on markets and risk assets. However, those relationships seem to have broken. Bond yields have gone higher, and equity markets are now at all-time highs after the best quarter to start a year since 2019.
Recession fears for the U.S. economy have disappeared. Much like how we finished last year, artificial intelligence (AI) remains the dominant theme. And while Nvidia and other semiconductor names continue to race higher, it’s very encouraging to watch how other sectors are now joining the party and moving higher.
Last year, equity returns were very narrow and dominated by the so-called “Magnificent 7,” but that has changed. It started with energy, as everyone suddenly realized these data centres required power. But now that is spilling over to copper and other commodities as a play to wire the servers together and build power lines. Even the banks are moving higher, with many hitting all-time highs. That is commonly known as a Bull Market.
But it’s not just equities that are moving higher. All assets are moving. Gold has broken out to all-time highs, even in the face of a higher U.S. dollar. And the “digital gold” of Bitcoin is up almost 100% year to date, racing to $70,000 on the back of the U.S. spot ETF and excitement over the halving, which will happen in April.
Putting it all together, you couldn’t have asked for much more from this quarter. Markets will climb the “wall of worry,” and that has been the case. Equity markets around the world, along with commodities and crypto, are at all-time highs. Which should cause investors to question what we were so worried about a few months ago.
However, it’s not the time to blow the “all clear.” Even with all the good news, markets continue to expect rate cuts this summer, which will open themselves up to disappointment if those do not occur. While the American economy continues to rock, other places in the world, including Canada, are not in as strong a position. Recession odds have fallen, but they haven’t fully gone away; a recession could be more delayed than cancelled.
We continue to think equities will see their highs in the first half of the year as there is no way the U.S. election will not cause uncertainty, which markets hate. That is contrary to the traditional pattern during an election year, which is often sideways until the election and then vaulting higher after election results.
The next quarter should see much of the same things we experienced this year. Inflation and payroll numbers will remain key indicators of market direction. Geopolitics remains an unknown risk that markets have largely ignored, yet it could flare up at any time. Further tensions in the Middle East that send crude oil prices higher could quickly derail the good news story of inflation falling.
Corporate earnings may have been the most positive surprise for many. Consumer demand has held despite fears, and margins have not faded. As we enter the next earnings reporting season, we will continue to listen for signs that this trend is shifting.
Equity markets have touched or exceeded many year-end targets. The good news is that it happened for the right reasons, with earnings higher and recession fears fading. Many were underinvested to start the year and are now chasing to deploy capital. But this is where it gets tricky. Complacency is setting in for many, and “bearish” sentiment is near the lowest level in years. With many investors lagging benchmarks, the “pain trade” is higher. Seasonality remains positive for the next month, but everyone needs to remain alert for any change of tone that could cause some volatility.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
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