Global Equity Weekly

August 04, 2023 | 16:27

The Rating Game

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Equity markets slumped this week alongside a sharp selloff in the bond market through Thursday, and some mixed economic data. The S&P 500 was down 2.3%, with weakness in rate-sensitives and technology, while all other sectors but energy were in the red. Meantime, the TSX was down 1.4%, with all but energy also posting declines.

U.S. payrolls came in a bit weaker than expected at 187k in July, while the unemployment rate fell a tick to 3.5% and wage growth was a firm 0.4% (+4.9% y/y in the month). Elsewhere, the manufacturing PMI was still showing contraction; the services PMI slowed but was still expanding in July; while factory orders and auto sales were decent. That combination seemed just right to keep equity investors satisfied and the bond bears at bay, at least to end the week. Indeed, the Treasury market was where the real action was this week, with a sharp move to higher yields and a steeper yield curve, before some reprieve on Friday. The 10-year yield is now up more than 30 bps since late-June, while the 30-year has been hammered by more than 60 bps from the spring low. The reasons, there are many. This week’s downgrade of the U.S. credit rating by Fitch (to AA+ from AAA) simply shone more light on what we already know—that the U.S. fiscal situation is not good. All the while, Japan’s recent move on JGB yields, ongoing QT, some supply concerns and a move back up in oil prices have played a role.

For equity investors, this lurch higher in yields doesn’t help the valuation picture, as the spread between the S&P 500 forward earnings yield and the 10-year Treasury yield has compressed to about 1%, a low level not seen since we were coming out of the tech bust in 2002. We’ll remind all that lofty valuations are never sufficient to cause problems on their own, but things are suddenly looking a bit pricey when set against this yield environment (much less so in Canada).

Speaking of Canada, where does the U.S. downgrade leave their neighbours to the north? Fitch already downgraded Canada during the height of the pandemic in 2020 (to AA+), while the other big-three rating agencies still rate Canada AAA with a stable outlook. In absolute terms, fiscal hawks have been sitting a bit uneasy in Canada alongside large-scale pandemic-era support, a continuous flow of new program spending and a rising tax burden. But, in relative terms, Canada looks downright responsible when set against the U.S. performance.

Major Index Performance

North American Sector Performances

(% change over period)

Table 1 - S&P 500 Sector Performance

Source: BMO Economics, Bloomberg

Table 2 - TSX Sector Performance

Source: BMO Economics, Bloomberg

TSX Relative Sector Performance

(relative to the index, year-ago = 100; dashed line = 200-day m.a.)

S&P 500 Relative Sector Performance