- Equity markets were choppy again this week, walking a tightrope of ongoing troubles in the bank sector, and a less hawkish Fed. The S&P 500 finished up 1.4%, as gains across most sectors were dampened by weakness in banks and utilities.
- During the trials and tribulations of the past month, what has help up best? Communication services, technology and large caps. That is, areas of the market with valuations typically driven by interest rates (more on that below).
- Meantime, the TSX added 0.6%, with banks, industrials and utilities weighing heavier.
Last week, as expected, the U.S. Federal Reserve raised interest rates by 25bps. But despite these expectations, markets weren’t happy—they had priced in the rate hike, but were looking for more cautious and dovish comments from Fed chairman Jerome Powell. Powell did mention that the current banking situation (i.e., tightening financial conditions) was similar to rate hikes but then still followed ahead with the rate hike regardless. Furthermore, the dot plot looked fairly aggressive and Powell emphasized that the central bank still needs to stay on top of inflation. Now, the question for markets is—what happens if inflation proves stubborn? We don’t have an answer to that question yet, but we do know that investors didn’t get the end-of-rate-hiking-cycle signals they were hoping for. In terms of the ongoing banking situation, there’s obviously been evidence of instability, but Powell and U.S. Treasury Secretary Janet Yellen are holding the line that there’s no systemic crisis. Yellen actually said that they would protect any bank that runs into issues if they think it would be a threat to financial stability. However, she did NOT say that bank deposits for all banks were fully insured. In this respect, the Fed, Treasury and markets seem to be on the same page—if they really felt the banking crisis was going to worsen significantly, the Fed would have paused, and markets would have tumbled much more than they did. Markets are viewing the banking situation as more isolated with minimal contagion effect; as a result, the focus remains on inflation.
Bottom Line: It’s too early to tell where markets are headed, which is why a balanced strategy makes sense.
Global Financial Stability
The Fed raised interest rates, but where do other central banks stand? The Bank of Canada appears unlikely to hike rates—they may have been on the fence previously, but recent developments, including declining Canadian inflation numbers, justify their pause. Despite instability in the banking sector, the consensus among central banks around the world seems to be that we aren’t headed into a global financial crisis. Credit Suisse, Silicon Valley Bank (SVB), Signature Bank and First Republic all represent somewhat different scenarios. Despite its history, Credit Suisse wasn’t among the best-managed firms, nor a top-quality bank. The Swiss National Bank did a good job intervening, and the fact that Credit Suisse’s assets were acquired by a better-capitalized bank should put a stop to any contagion concerns. The SVB situation was not really a banking issue per se—it was more of a problem for entrepreneurs and venture capital firms. There’s no question that it impacted them significantly, but it’s not the type of crisis that would be expected to take down markets. Furthermore, First Citizens Bank has bought up quite a few of the assets from SVB over the weekend. First Republic hits a bit closer to home. But even then, other banks have stepped in to help because they realize that if depositors start talking about pulling their money, it could lead to more problems down the road.
Bottom Line: Central banks talk to each other, and the fact that many are still raising rates tells you that they don’t think we’re in a financial crisis.
Our expectation for earnings season is that results will be lukewarm. We’re likely to continue to see some disappointment, as well as comments about job losses and inflation. There will obviously be a few stand-out companies, with some firms outperforming guidance after lowering expectations. But in general, we don’t expect an exceptionally strong earnings season. What we may see is a greater divergence of stocks on the active management side, with large, quality companies able to withstand inflation and interest rate pressures while smaller-cap firms struggle. But even then, the trend won’t be across the board: Nike’s earnings disappointed and Lululemon’s was a bit more positive while both Meta and Amazon announced more job cuts.
Bottom Line: Companies have realized that cost containment is worthwhile and that the second half of the year will be more challenging, which means more job losses.
A detailed breakdown of our portfolio positioning is available in the latest BMO GAM House View Report, titled Banking and Bad Apples: The Aftermath of SVB. One recent change worth highlighting is that we’ve taken down our equity position in our more conservative ETF Portfolios by 2-3%—if the banking situation had worsened, we didn’t want our more conservative clients to be significantly impacted, and if it didn’t, we were still positioned to capture upside through other tactical shifts. For our balanced and more equity-heavy portfolios, we remain neutral on equities, overweight bonds and underweight cash. This has proven to be the right call—even after the disappointment over the Fed’s rate hike last week, markets rebounded the next day. In that kind of up-and-down, higher-volatility market environment, we think balanced is the right strategy.
Lastly, I look forward to seeing many of you at our event in Nashville next week, where you’ll have an opportunity to speak with me and our PMs in-person and hear more about our perspectives on markets and the economy.
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