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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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Yes. The Fed is always late; that's not a fault, it's the result of the process. Only the history books will tell us whether they've been too late. Too late means that they don't act until there's an event that they could have prevented if they'd acted earlier.
He can't see any indications showing that the US economy is in the path of harm. But these things can happen fairly quickly. There's no question that the labour markets are weakening, but "weakening" is a lot different from "weak". Fed Chair Powell has been very fond of saying that they're "data dependent". They have to wait until they see something before they act, can't just act on an idea.
It's a serious issue, they have to be measured, and they're doing that.
He expects 25 bps. Could easily do 50, but that might send the wrong message. If the market senses that the Fed is lowering rates because they're fearful of a weak economy, it will react very poorly. The Fed doesn't want to upset the markets, they want to be benign as they relate to the market.
It's not a very well hidden fact that this is just the start. He fully expects that before this cycle is finished, we'll see at least 100 bps drop in rates (even if that moves into 2026).
It'll be interesting to see how the markets do react to this afternoon's press conference. It's not the 25 bps that markets will react to. He's waiting to see if the tone is dovish or hawkish, how many dissents on the board there are, and how many board members would have actually preferred 50 bps. He'll be watching how the market grapples with the message from the written side (decision itself, dissents, dot plots) and from the nuances (how Powell answers questions).
Premium contentBOC and the Fed both cut by 25 bps yesterday. Broadly speaking, that's good for the valuation of all risky assets because risk-free rates are the foundation of the cost of capital for companies. Lower rates tend to lead to a re-rating, and we've seen that today.
His team focuses on two long, North American, high-conviction, best-in-breed portfolios. One mandate looks for companies that have a demonstrated history of growing dividends, underpinned by a strong competitive moat. The other, more aggressive, mandate looks for companies with very strong fundamental momentum.
It's a 2-speed economy. The job market isn't terribly healthy in either US or Canada. The experience of the median household in the street is not all sunshine and roses. Yet we have corporate profits and equity indices at or near all-time highs.
To capitalize on that, their portfolios remain predominantly invested in mid-cap, and especially large-cap, enterprises. These tend to have more resilience, more robust structural profitability, and (crucially) a more global orientation.
Likes them. About 10% of his firm's dividend growers mandate is invested in them. A leveraged play on the economic growth of the regions they operate in. Economic growth has been tepid and lacklustre, Canada's GDP print for G2 was negative.
But market's forward looking, and bank prices reflect that we're likely to see an acceleration in the economy. BOC rate cuts set that in motion and added fuel to the fire yesterday. The Major Projects Office policy thrust is very encouraging. We're going to cut red tape and build things. A game changer. These projects will be debt-financed, which should be growth-positive for the banks' lending books.
Stable, well-governed, well-managed, tight oligopoly. Must-have for businesses and individuals. His portfolios are long and strong this area. Prefers the larger banks, smaller ones just don't have the scale.
Note that EQB has had some tragic turnover in the C-suite, and LB is broken.
Absolutely. Investors have a lot of money on the sidelines, just waiting for a buy signal. Ironic in that people wait to buy when everything's up. But it really does work that way psychologically. With the market going up, people are confident. And with interest rates going down, GICs and such aren't looking so good. It starts a slow wave of $$ coming back into the market.
That usually continues until something goes wrong. And you never know what black swan event is going to happen. Right now, the confidence and the interest rate movement are really positive for equities in general.
Yesterday was great. We've had some really big moves and are starting to see some M&A activity. Market confidence has to last for a period of time before people say it's time to buy the small companies. They will move and be volatile, but we've had 4 or 5 false starts to a small-cap rally in the last 3 years.
Any time inflation picks up, small caps get a hiccup because they're quite sensitive to rising rates. There's no one indicator that signals a small-cap rally. Things just slowly build until investors get more confident and willing to take more risk.
When people talk about risk in small caps, what they really mean is price volatility. But there are lots of small caps out there sitting on $100s of millions of dollars in cash, and their fundamental risk is not that big. But some of them are much less risky than a large cap sitting on $100s of billions of debt, which will get hit if interest rates go the wrong way.
In Canada, small-cap golds are up 60-70%. Just ridiculous in terms of how well they've done. Starting to see some industrials move.
Starting to see small caps transition into big caps, and CLS is the best example of that. It went from a dopey little company 5 years ago to today's $30B market cap. ATZ is another example. That's what small-cap investors want to see.
In general, people are still gravitating toward $2-3B companies rather than $500M companies.
Doesn't think it will get eaten, but a lot of software companies need to adapt. They can either make acquisitions to make themselves more competitive, or hire smart developers to create in-house AI solutions. There will be a lot of angst and a lot of investor uncertainty.
Some will suffer, but others will adapt and prosper.
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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.