Looking Back and Looking Forward
Despite a weak September, Q3 saw the Canadian and U.S. equity markets rise ~1% and ~2%, respectively, On the surface, things seem to fine in equity land, but when one looks beneath the surface, there are some notable issues.
As in recent quarters, the S&P 500 has been carried by a small number of AI-related names; by contrast, the majority of individual stocks in the S&P 500 are in either correction (-10%) or bear market (-20%) territory. This lack of market breadth makes us quite uncomfortable.
Speaking of uncomfortable, bond yields, as measured by the U.S. 10-year Treasury Bond, rose by over 90 basis points in Q3 – a large rise in interest rates in a short period of time. Pick any reason you like – the U.S.-Iran war keeping oil prices elevated, deteriorating government finances, escalating debt issuance for AI capex – but it’s most likely a combination of several factors.
Despite higher bond yields, equity markets have remained resilient. We think interest rates will push higher still, and if that happens, we may see the equity market’s resolve get challenged. We’re frankly quite surprised by the lack of any weakness in the broader equity market up to now, given the recent rise in bond yields. While U.S. index composition favours the megacap/AI heavyweights that are less rate-sensitive, yields/rates simply should not be completely ignored. Interest rates matter to leveraged households, businesses, and governments, and it’s difficult for these economic participants to withstand the pain of “higher for longer” rates. Things may be different this time, but we don’t think so.
Our Core Model Portfolios
In our core capital growth models, we trimmed our European and Developed Asia equity exposure, as well as our overall equity exposure, in July (post the trim, we remain underweight U.S. equities and overweight rest-of-world of equities). We redeployed some cash into domestic T-bills, keeping fixed-income duration low given our view on higher rates in the future.
In our core income model, we closed some positions and took profit, redeploying cash proceeds into some existing portfolio names in which we have long-term conviction.
Very soon, companies will begin reporting Q3 results; furthermore, U.S. midterm elections are less than a month away. Either or both could be significant market catalysts in the near term. As always, we’ll be monitoring these and other developments to help inform any portfolio actions we take for our clients.