The stock markets performed well in July as the Nasdaq gained 5.28%, the Dow Jones 3.48%, the S&P 3.61% and the TSX 2.43% for the month. The year-to-date performance figures for the indexes to the end of July are shown below. Central banks continue to raise rates in July as the Bank of Canada, the Federal Reserve and the ECB all raised rates a quarter of a percentage point to the highest rates in 22 years and are signaling that they are likely to continue to raise rates until their 2% inflation target is achieved.
Fitch rating agency downgraded the US government credit rating from AAA to AA+ citing “a steady deterioration in standards of governance.” Moody’s just released a rating downgrade for some US banks, and they are reporting that further downgrades are likely to come. The downgrades will have an adverse effect on the cost of borrowing for these institutions. The impact of the rate increases over the past year plus for the banks is putting pressure on their profit margins and capital levels. Moody’s has also reported on concerns for the commercial real estate market in the US that has been a topic of discussion for the past couple of years but significant impacts on the banks have yet to materialize.
China economic indicators are showing a slowing of the economy to a greater degree than anticipated. North America is faring well as the economic conditions and the job market are still strong. Europe is holding up well with the U.K showing the most weakness.
Inflation is coming down, albeit not to the level central banks are comfortable with, but the trend is lower. Earning reports by companies are a mixed bag with many giving weaker guidance. The sectors that are impacted to a greater degree by rate increases such as financials, utilities, health care, and real estate are still struggling but are offering yields of 6%, 7% and greater as interest rates rise and expectations for further increases are reflected in the price of securities. Given many of these negative points, the market has moved higher and shrugged off bad news to a much greater degree than it did a short time ago. As we have pointed out before, the market is a leading indicator and when bad news is reacted to with moves higher or with no material negative impact it is a sign that the markets expect things to get better in the next 12 months or so.
We believe, barring a significant event going into the fall, that the market has signaled that things are moving constructively, and we anticipate further positive gains ahead. It is time to take advantage of the higher yield being offered as the interest rate cycle of increase is nearing its end. At some point rates will come down, not to their prior lows but from their peaks and positioning in higher yielding securities that have solid balance sheets and provide opportunities. The fixed income securities that are positioned at the top of the rate cycle will not only provide higher yields but will have the additional advantage of capital gains once the interest rate cycle turns to reducing rates. There will most likely be some level of technical recession in North America in 2024.
In summary, at Investment Strategies our stance remains unchanged, as we are constructive but defensive on the market. We feel that it will not be until later this year, past October-November to determine if any significant issues or events will emerge that would have a material impact on the stock market, such as material bank failures, commercial real estate issues, and debt restructuring due to high rates. The market is telling us to be constructive as it reacts well to negative news. Companies that provide negative earnings guidance, especially in the tech sector, are being punished. As we commented last month it appears a new bull market may have begun as the signaling of further rate hikes by central banks are having little negative impact on the stock market. The market may be looking past rate increases as we are near the end of the tightening cycle and the economy is still performing well under higher rates and the employment picture remains robust. There are powerful economic conditions such as the move to sustainability, tight labour markets, adjustments to global supply chains away from China, technological changes and demographic trends that will continue to positively impact the economy and stock market for quite some time.
A Summary of equity index performance YTD to end of July is outlined as follows:
Dow Jones Industrial Average + 7.28%
S&P 500 +19.10%
Nasdaq +35.80%
S&P/TSX + 6.41%
The current prime interest rate in Canada is 6.95% and 8.50% in the US.
