October 08, 2024

Markets Overview

Equity markets extended their gains after a strong start to the year. Moderating inflation, resilient economic growth and central bank rate cuts provided further support to stocks. This quarter the US Federal Reserve began their highly anticipated rate cutting cycle with a strong start, reducing interest rates by 0.5% rather than a more typical cut of 0.25%. The larger cut was viewed as a response to a softening labour market. The Bank of Canada also continued to relax financial conditions in response to moderating economic data.

Equity markets exhibited some volatility in August and September with brief declines, a function of negative revisions to employment data and softer leading indicators. However, a recovery to new highs occurred as bond yields fell and central banks cut rates. This environment has led to a notable shift in market leadership. Interest sensitive sectors including utilities, real estate and financials were top performers and tech stocks underperformed as investors focused on equities with lower valuations. Canada also significantly outpaced global equities in the quarter.

Core fixed income had a strong quarter after generating a negative return in the first half of the year. The FTSE Canada Universe Bond Index was up 4.7% benefiting from a tailwind of lower bond yields. Credit markets remained strong as central banks cut rates and there continues to be demand for the attractive yields these bonds offer. 

Portfolio Strategy

The economic environment has been supportive this year and there are reasons to remain positive. The labour market has been solid and consumer spending has been resilient. Wage gains and a wealth effect from growth in investments and homes the last couple of years are helping the consumer. Yet there are also reasons to be cautious. Consumer confidence regarding the future is still suspect. In Canada, there is some financial friction as mortgages are being renewed at higher rates relative to legacy rates that were quite attractive. These forces have driven a shift in sentiment as consumers are cautious and sensitive to a higher cost of living. 

Given the investment landscape we have become more cautious in our equity positioning. We are focused on companies with resilient earnings and strong cash generation as they will fare better than the overall market if earnings estimates are too high. At the same time, we are also finding value in some sectors that have underperformed in recent years. These include consumer discretionary and communication services in Canada. We also see opportunity in small cap stocks which have been trading at a discount to large cap names despite their higher long term growth potential.

Within fixed income we saw continued volatility in traditional core bonds. We expect short term yields to fall further but believe that longer term yields may face some upward pressure. This means the outsized returns we witnessed in the third quarter may not repeat in subsequent quarters. Instead, we have been reducing portfolio interest rate sensitivity by allocating more to credit. The backdrop for credit has been very strong and company balance sheets remain solid.

Despite some uncertainty in the economic outlook the environment remains positive for equities and credit. Alternative assets also remain attractive both in terms of return and the benefits of diversification. Regardless, our investment teams remain more cautious considering the better-than-expected market strength we already experienced and sporadic evidence of a slowdown. We maintain a relatively balanced view given the opposing forces in the market and continue to allocate to areas of opportunity. The investment environment has produced significant returns so far this year, which has compounded capital after a strong 2023. If markets become more volatile and uncertain, we know that a diversified approach inclusive of different asset classes, strategies, and active stewardship will continue to benefit client portfolios. 

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