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Larry Berman CFA, CMT, CTA A Comment -- General Comments From an Expert A Commentary COMMENT Sep 09, 2024
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This rally has been one that everyone's hated because it didn't make a whole lot of sense. We still have all this tariff noise, though there has been some de-escalation. A lot of hedge funds sold near the bottom. People are scrambling to try to keep up and chase this market higher.
Tariffs are hard for people to deal with. There's an acronym going around -- TACO (Trump Always Chickens Out). And it's what the market is starting to believe. By and large, what market participants got wrong in April was that earnings in the US and Canada actually held up better than people thought. Forward guidance held up better. There is some de-escalation, maybe 2 steps forward and 1 step back (as today with China).
You have to ask yourself some questions. Does Trump want to be unpopular? No. Does he want to lose the midterms, which are not too far off? No, but he probably will if he puts the economy into recession. Softer inflation data came out in the States today. But it's sell in May and go away, and we still have this opaqueness.
We end up with the next 18 months looking pretty good, with a big beautiful bill coming in with deregulation, tax cuts, spending, etc. And all that will be good for the economy. But the short term will see tough markets.
What they're saying is that this number captured the front-running of trying to get ahead of tariffs, and that we'll still see the negative effects. But there is all this optimism with this new government being much more stimulative for Canada. Getting more projects off the table and boosting inter-provincial trade.
It's nice to see this better-than-expected number. What does that mean for the BOC next week? Probably will be on hold and not lower rates. Our currency is going up, which isn't as much a secular Canada call as it is a weak greenback.
Investors can take comfort in that he thinks we've seen the big moves down. But we're still going to have trading ranges. Markets are back near highs, so you don't need to go full-in. And it is May.
New money always has to be put to work. So you have to ask yourself: what should I own, and how much of it? Where should I be on asset allocation -- at, over, or under? And it all depends on the economic outlook, which is hazy. Prices are expensive here.
So he's trying to find places that are going to work regardless of the cycle.
You still have to own US stocks, especially if they're cheaper and more compelling.
He might be naive, but we have Team Carney in place. You have to be considered a "bad country" to be punished with taxes to such a large degree. He believes we'll be able to avoid the worst. It might mean going against the OECD. But Canada has to do what it has to do.
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You have to think about what consumer prices are going to look like and how consumers may have to cut back. 2/3 of all economic growth comes from the consumer. If they have to cut back on spending, then changes are that profitability may be weaker in the coming quarters.
His team sets a plan and sticks to it. In a 30-stock portfolio, he'd have about 4 Canadian, 13 US, and 13 international. It's not where the companies are domiciled, it's about where the revenue streams are coming from.
He's gotten emails over the past weeks about the CAD vs. USD. Important to understand that currency risk becomes benign over a 10 to 20-year time horizon. If you think about the USD vs. CAD, the annual change over 25 years has been 0.2%. With Europe, it's been 0.6%. So don't fret.
His approach is to have a list of stocks, and each client's portfolio is customized with 30 names. They look at the percent weightings in the portfolio. When it comes time to do some buying, they look at the ones with the lightest weight because those are the ones that are down the most. The expectation is that, at some point in time, profits will return and stock prices will turn around and start to go up again.
Stay in the game. Protecting your losses is much more important than how much you make.
The way they manage risk is to not only keep the percent weightings in line, but also to keep 50% in the 4 inelastic industries: consumer, healthcare, financials, and utilities. The other 50% can go in the more volatile technology or industrial sectors. By country, again, he keeps that 20/40/40 mix among Canada, US, and international.
He wants to have 50% in large caps, where most of the profits are being used to pay out dividends, and that's the income side of the portfolio. Still wants to have another 40-50% in small-mid caps; that's because more of the profits are going back into the business for capital appreciation over time. This way, you get that nice blend of income and growth. Dividend growth offsets inflation.
He doesn't have to chase sectors or areas because they're already global managers. So when EMs and Europe took off, they were already there and benefited from it.
He favours insurance companies over banks right now. What's going to happen when all those people who bought houses in 2020 with 20% down, with 5-year fixed mortgages at 1.5%? The value of their home has dropped 20%, now they have no equity in their house, and they suddenly become high risk.
Canadian banks haven't yet had to face this problem. If payments double or triple, and more income has to be allocated to debt repayment, that will impact loan loss provisions and profitability. Most banks raised provisions, but not enough. BOC may have to lower rates to keep the economy going, and that's not good for banks either.
Trump will have better corporate tax policy and better individual tax-cutting compared to Harris. But the impact will be far worse for deficits going forward. This matters a lot. Because it's such a close race, this adds a lot of uncertainty over the next 2 months.
As always, it will come down to a couple of swing states. Most important one and closest race is Pennsylvania. US Steel takeover is a big focus there. It almost doesn't matter who wins the presidency, because tax policies get voted on by Congress. Whether we see a blue sweep or a red one, what does that mean?
According to polls, slight tilt now toward the GOP in Congress. Slight tilt toward Harris as President. Senate looking to be Republican. Likely going to be a split outcome, which is actually the best for equity markets based on the last 70 years. Until we get beyond the election, it really matters.
For the individual, everybody gets a tax cut under Trump. But do the top 10-20% need it? Vast majority of spending in his package will benefit the rich, by far. For Harris, the top 10% will pay a bit more, but the bottom half will be way better off.
At the end of the day when all's said and done, he thinks Harris will get the nod.
What does all this mean for equity markets as we head into the next couple of months? We've seen added volatility in markets since about mid-July, when Harris entered the race and Biden left. Favourable inflation numbers, but weakening labour situation. Worry in first days of August with Japanese carry trade, they changed policy, markets rallied but could not make a new high. 50-day MA was broken on Friday. Need to test support before we can rally, and support is about 3-4% below where the S&P 500 is sitting right now. Very high probability of testing that between now and the September 18 FOMC meeting.
If Fed does 50 bps, and is really worried about the economy, support will break and we'll come back down. If they do 25 bps, suspects we'll see a bit of a bounce, but ultimately don't expect new highs until US election results are in. Market's in a holding pattern, with volatility, between now and election day.