October 2024 Portfolio Management Team Update

Elvis Picardo

October 6, 2024

October 2024 Portfolio Management Team Update
By Elvis Picardo, CFA®, CIM, Senior Portfolio Manager, iA Private Wealth
October 3, 2024

Market Review
Global equities advanced to new highs last month to cap a volatile quarter, as interest rate cuts by major central banks boosted optimism for a soft landing despite mixed economic data.

The TSX rose for the third straight month, up 2.8% in September to trade at a record high of 24,000 on the last day of the quarter. The index’s third quarter (Q3) surge of 9.7% was its best quarterly performance since Q2 2020 and took its YTD gain to 14.5%.

Q3 gains were led by the financials group – which accounts for almost one-third of the TSX – with a 15.8% surge, as Royal Bank rose to a new record while other Canadian banks rose after reporting strong earnings. The materials sector gained 11.7% in Q3, buoyed by higher metal prices, while the energy sector lagged, up only 0.8% in the quarter. Smaller sectors on the TSX including technology (+14.0%), utilities (+15.3%), health care (+15.8%), and real estate (+21.9%) also posted robust increases in the quarter.

In the U.S., the S&P 500 recovered from the second successive monthly jobs report-induced plunge in the first week of September, much like the swoon in the first week of August that had taken it to the brink of a correction. The index rose 2.0% last month and 5.5% overall in Q3, taking its YTD gain to 20.8%, the best performance in the first nine months of the year since 1997.

The S&P 500 advanced to new highs in Q3 despite market leaders like Nvidia and Amazon posting nominal declines in the quarter, as the rally broadened out beyond technology mega-caps. The S&P 500’s equal-weighted version gained 9.1% in Q3, beating the traditional cap-weighted index by 3.6%, the biggest such margin of outperformance since Q4 2022 (Figure 1).

The Dow Jones Industrial Average (DJIA) rose 1.9% last month and 8.2% in Q3, although its 12.3% YTD gain lagged the S&P 500 and Nasdaq by a wide margin. The Nasdaq Composite’s 2.7% advance in September enabled it to post a 2.6% gain in Q3, significantly slower than its surge of over 8% in each of the preceding two quarters, but good enough for a YTD performance of +21.2%. While small-cap stocks outperformed their large-cap peers in Q3 with the Russell 2000 up 8.9% vs. 5.7% for the Russell 1000, large-caps are still trouncing small-caps YTD by close to a 2:1 margin (+19.9% YTD compared with +10.0%).

The MSCI AC World Index advanced 1.2% overall in August and 4.4% in Q3 for its fourth straight quarterly gain; the index was up 17.2% YTD as of September 30. While most European indexes posted gains in Q3, China’s Shanghai Composite and Hong Kong’s Hang Seng index were among the star performers globally as they rose 12.4% and 19.3% respectively in the quarter. Both indexes surged 17.4% last month after the Chinese government unveiled a raft of stimulus measures on September 24 that included interest-rate cuts, freeing up of cash for banks and liquidity support for stocks.

(Sources: FactSet, Bloomberg)

Figure 1: U.S. market rally is getting broader

Economic Highlights
Central bank moves were front and centre once again in Q3. Interest rate cuts dominated the economic agenda, with September witnessing the biggest month of global monetary policy easing since the pandemic crash of April 2020. The Organization for Economic Cooperation & Development (OECD) noted in a recent report that the global economy is settling into a period of stability as easing inflation allows central banks to loosen monetary policy in a measured manner.

Meanwhile, Canada is the first G7 central bank to slash its policy rate three times already this year (Figure 2), due to growing unemployment and per-capita GDP that has contracted by about 3.5% over the past couple of years. The Bank of Canada cut its benchmark overnight rate by 25 basis points (bps) to 4.25% on September 4 and reiterated that it’s reasonable to expect more easing if inflation keeps decelerating.

As for inflation, Statistics Canada reported last month that Canadian CPI rose 2% in August from a year ago, the slowest annual pace in over three years. Slowing inflation and lower interest rates have led to Canadians turning the most optimistic about the economy since 2022, despite challenges such as near-record levels of mortgage and other debt, and a sluggish job market. Canada’s jobless rate reached 6.6% in August, an increase of 1.6% percentage points since the start of 2023, while recent data shows economic growth tracking at only around 1% in Q3.

Some economists expect the Bank of Canada may slash its policy rate by 50 basis points at its next meeting on October 23 to prevent further economic weakness. Most market participants expect the Bank to pull off a soft landing for the Canadian economy even if it cuts rates in a measured manner, with the forecast calling for the rate to fall to about 2.5% by July 2025.

Figure 2: More cuts coming from the Bank of Canada

Over in the U.S., the Federal Reserve on September 18 slashed its benchmark interest rate by 50 basis points to a range of 4.75% – 5.00%, while signaling that it is no rush to ease policy. Traders currently see a 33% probability for another 50-bps cut at the Fed’s next meeting on November 7, with the Fed expected to cut rates to “neutral” territory of about 2.9% over the next 12 months.

With the prospect of more interest rates to come, bond yields have slipped appreciably in recent months. In Canada, the 10-year government bond yield is presently at 3.02%, down 13 bps over the past month and a full 100 bps below the year-ago level. In the U.S., the current 10-year Treasury yield of 3.79% is down 11 bps over the past month, well below the multi-year peak yield above 5% reached last year.

The U.S. economy continues to chug along, with the Citi US Economic Surprise Index showing that macroeconomic data is again exceeding expectations for the first time in five months (Figure 3). While the ISM survey of manufacturing remains mired in recessionary territory for over a year, data just released shows that the ISM index of services expanded in September at the fastest pace since February 2023, driven by new orders and stronger business activity. The Bureau of Economic Analysis reported last month that the U.S. economy bounced back from the pandemic stronger than previously estimated, spurred by robust consumer spending; the economy also expanded at a 3% pace in the second quarter, following a 1.6% growth pace in Q1.

Figure 3: Positive “surprises” in U.S. macro data after five months

Outlook & Portfolio Strategy
Judging by the record levels at which equity markets are currently trading, combined with earnings growth expectations for 2025, it is evident that optimism about a soft landing is running rampant. This raises the risk of a significant market drawdown even if a mild recession materializes. As we noted in last month’s update, investors may be disappointed if economic data shows significant weakness – thereby derailing the soft-landing hypothesis – or if inflation proves to be stickier than expected, causing them to reconsider optimistic assumptions about future rate cuts.

September this year fortunately did not live up to its billing as the worst month historically for equity performance. However, the notoriously volatile month of October could justify its reputation, based on the number of exogenous events that could shatter investor complacency, such as the escalating conflict in the Middle East, a contentious U.S. Presidential Election or even a protracted strike by U.S. port employees (which has halted 50% of the nation’s container traffic).

Will we see a resurgence of the volatility that gripped markets on two separate occasions since late July? Global stock markets erased $6.4 trillion in a three-week rout that ended in the first week of August. A month later, the S&P 500 and Nasdaq Composite fell over 4% and almost 6% respectively in a week, led by Nvidia’s 14% plunge that briefly wiped out over $400 billion in the world’s largest AI chipmaker.

Earnings estimates for the TSX and S&P 500 suggest solid profit growth in 2025. Based on FactSet estimates, earnings per share (EPS) growth for the TSX Composite is expected to increase from less than 4% this year to 12.5% in 2025. Based on the TSX Composite’s current level of 24,000 and forecasted EPS of $1,462 for 2024 and 1,644 for 2025, the index trades at multiples of 16.4x fiscal 2024 (FY24) EPS, and 14.6x FY25 EPS.

The S&P 500 is forecast to achieve faster EPS growth over that timeframe, 10.3% in 2024 and 15.0% in 2025 (source: FactSet). Based on the S&P 500’s present level of 5,709 and forecasted EPS of $239.75 for 2024 and $275.67 for 2025, the index trades at a steep 23.8x FY24 EPS, and at a more reasonable 20.7x FY25 EPS.

Those ambitious EPS growth projections may be attainable if the U.S. and global economies skirt recession, because the “other 493” – the S&P 500 minus the so-called Magnificent Seven – are now beginning to catch up in terms of earnings growth (Figure 4). The health care sector, for example, increased earnings by 16% in Q2, after seven consecutive quarters of profit contraction; earnings are forecast to increase over the next few quarters, with profit growth projected to reach 45% in Q2 2025. The Magnificent Seven grew earnings by 36% in Q2, down from over 50% in the previous three quarters; earnings growth for this group is forecast at 17% to 20% in the next four quarters (source: Bloomberg Intelligence).

Figure 4: Earnings growth from “Other 493” catching up to Mag 7

This dramatic improvement in prospective earnings for the rest of the S&P 500 bodes well for a continuation of the rally. With the rotation trade that began in the first half of July continuing apace, groups other than the Mag 7 have led the advance since then (Figure 5). BlackRock’s analysis of six rate cycles since 1984 reveals that sectors including healthcare, consumer staples and utilities are the strongest performers one year from the first Fed rate cut (Figure 6).

Figure 5: Other sectors are (finally) leading the charge

Figure 6: Health care and staples outperform a year from first Fed cut

Source: BlackRock Fundamental Equities

Despite occasional hiccups and wildcard risks mentioned earlier, investors seem to be in full “risk on” mode, with the rally having spread in recent weeks to relatively riskier assets including emerging-market equities and small-cap stocks. Of the 499 respondents in a recent Bloomberg Markets survey, 60% said they expect US equities will deliver the best returns in Q4 (Figure 7).

Figure 7: Sticking with US stocks

The Portfolio Management Team (PMT) made significant changes to its large model portfolios in Q3. In mid-July, the PMT sold individual stock positions and deployed the proceeds in diversified, actively managed ETFs. Among the notable changes was a modest increase in our U.S. exposure at the expense of Canada, based on our view that U.S. market leadership is unlikely to be challenged in the next few years, even as the Canadian economy struggles to gain traction.

With our client portfolios now having greater exposure to a diversified basket of the biggest and best companies in the U.S. and Canada, we expect portfolio returns that are more closely aligned with the markets, as well as lower portfolio volatility through enhanced diversification. Early evidence indicates that this approach is working, with client portfolios withstanding recent bouts of volatility better than their underlying benchmarks while still participating in most of the upside. The PMT will be reviewing its asset allocation in Q4 with a view to making changes that will position client portfolios adequately for 2025 and beyond.

Please contact any member of the PMT if you have any questions or concerns regarding your accounts.

This information has been prepared by Elvis Picardo, who is a Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.