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With the dog days of summer thoroughly entrenched, for those that haven’t looked at their portfolios for the last few weeks, it’s good to know that not much has changed. As we have seen throughout the year, equity markets continue to grind higher, overcoming all obstacles and crushing the bear arguments.
Heading into this year, one of the biggest fears for investors was around an earnings contraction. And while earnings have slowed, the results we have seen so far are nowhere near the doomsday scenario that many had been calling for. While the re-opening of the Chinese market after the lockdowns has not been the positive catalyst for global growth that some had been expecting, that demand has more than been made up for by spending from the U.S. consumer.
The most aggressive period of rate hikes by central banks in a generation has done little to put off demand for services in many parts of the economy. Goods consumption has slowed from the frothy levels of last year, and while we have seen a slowdown in demand for real estate, the overall economy is doing better than expected. Calls for an imminent recession are now also being pushed off until 2024.
As the predictions of a “soft landing” become consensus, a welcome change in leadership is beginning to emerge, and we may finally be getting close to seeing the rally broaden out. A lot has been written this year on how narrow the leadership of this equity market bounce has been, but during July, that slowly began to change as other groups joined the party.
One area to highlight has been the performance of the energy sector. This sector had led for much of 2021 and 2022 but has been a laggard this year. With the support of production cuts from OPEC and an increase in global demand forecasts, it was one of the top-performing sectors during the month. This may provide optimism for other commodities and for the performance of the S&P/TSX, which has lagged other markets so far this year.
The biggest debate for investors remains what to do with the leaders of the technology sector. The Nasdaq entered January coming off one of its worst years ever, but with the strong performance of the past seven months, it is back to approaching all-time highs. This has happened in the face of sticky high bond yields, which traditionally have been a headwind for the group. However, the mania around AI seems to have counteracted that threat. Will this continue to be the case? Or will reality set in and multiples return to normal as a potential “bear market bounce” fades? That will be the focus going forward.
August has historically been a challenging month for investors, and the period from August to October is filled with market events that many would rather have forgotten. With markets off to a strong start for the year, investor sentiment is near all-time highs. And with central banks nearing the end of their tightening programs, a contrarian fear is emerging around whether “this is as good as it gets.”
During the second half of the year, equity and bond markets will have many obstacles ahead of them. Credit conditions continue to tighten in many areas as the knock-on effects of the collapse of regional banks in March take hold, and while central bankers are signalling a pause in tightening, the prospect of rate cuts remains low. Will this have the long-awaited drag on earnings many were predicting last year? And while the prospects of AI growth remain positive, have we gotten ahead of ourselves when valuing many companies?
It’s been a great start to the year for many investors, which should be appreciated, but it doesn’t mean we are in the clear. While measures of volatility remain near all-time lows, we are just entering the time of the year when volatility begins to pick up. Summer is a good opportunity to reflect on what has happened year to date and to get ready for what’s ahead. While a rotation to the lagging sectors remains the best-case scenario for a move higher, we would caution against getting caught up in the hype and chasing winners. This isn’t a time for FOMO (fear of missing out), as that never seems to end well.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2023 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Macro commentaries” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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