Global Equity Weekly

June 30, 2023 | 16:28

Investors Hanging Tough

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)

Half of 2023 is now in the bag and financial markets have had plenty to chew on. The broad macroeconomic backdrop shows an economy holding on relatively well despite widespread concern about recession—many buffers in place for the economy are proving their worth. The flip side is that inflation remains stubborn, leaving both the Bank of Canada and Federal Reserve to grapple with short-term core metrics that are still well above their comfort range.

As a result, while the pace of monetary tightening has been dialed back, neither central bank appears done. Against that backdrop, financial markets have made it to summer in pretty good shape—a few themes:

The 60/40 rebound: Last year was marred by the worst balanced-portfolio performance since at least the early-1970s, based on a 60/40 blend of the S&P 500 and 10-year Treasury. So far in 2023, total returns are running just above 11%, helped mostly by a strong 17% bounce in the equity portion. Ten-year Treasury yields are still clinging to positive territory on a total return basis, but the recent move up in yields has weighed.

Combined, even if stocks and bonds go nowhere from here, it would be smack in the middle of the historical scatter of stock/bond portfolio returns—the average 60/40 return since 1971 has been right at 10%.

Canada lags: Canada’s version of the 60/40 portfolio (TSX and long federal bond index) has seen a much more muted sub-4% return this year, mainly because the TSX has lagged. As is often the case, this comes down to sector exposure, and Canada just doesn’t have what has worked this year—big-cap technology and communication services. On a sector-by-sector basis, the TSX has actually outperformed in six of the ten major groups, so this is largely a composition problem.

Tech carrying the load: Technology is up more than 40% this year in the S&P 500, and telecom services are up 36% (think Nvidia, Alphabet and the like). Indeed, the concentration of performance has been quite stark. Throw in consumer discretionary (+32%) and you have three sectors with 30%-plus gains, while no others are scratching double digits, and fully half of the major sectors are down on the year. This lack of breadth has been one area of concern, if it implies the move in equities this year is driven mostly by valuations alongside the Fed slowing its tightening pace.

Bad breadth? The concentration of gains in U.S. equities is certainly notable, but has it really been that bad elsewhere? Sure, the run in big U.S. tech has been off the charts, but, aside from a handful of poor performers, there has been some firmness. Geographically, major markets in the U.S., Canada, Europe, the U.K. and Japan are up this year. And, by size, small- and mid-caps in the U.S. are each up about 8%—not bad even if the big names have stormed ahead by 20%.

The laggards: Rate sensitives, banks and energy have in general struggled so far this year. Unfortunately for Canadian investors, what the TSX lacks in big tech, it more than makes up for with these three groups. U.S. utilities are one of the worst performing sectors in North America this year, while Canadian REITs are also in the red. While a slower pace of tightening by the Fed has arguably helped valuations in some areas of the market, the reality that rates will sit higher for longer has hurt these groups. The story in the banking sector has been well documented, from U.S. regional bank failures to a slowing earnings environment.

All told, financial markets were braced for a downturn coming into the year, and they were pleasantly surprised by the resilience of the economy. Looking ahead, that resilience has kept inflation firm and necessitated higher-for-longer interest rates. The outcome in the second half of the year will likely come down to what runs out of resilience first—inflation or the economy.

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