Each quarter, our Investment Management teams publish their key observations and portfolio updates across Global Equity and Fixed Income markets. This is a summary of our views for the Third Quarter of 2024. You can download the full reports via the links shown below.

KEY OBSERVATIONS

Yet another good quarter for both the S&P500 and TSX has come to a close, with the S&P 500 up +5.89% in U.S. dollars or +4.59% in Canadian dollars, and the TSX total return up +10.54%. 

The much-anticipated monetary policy easing cycle started earlier this month when the Federal Open Market Committee (FOMC) cut interest rates by 50 basis points as Chairman Powell signaled that he was shifting from an inflation hawk to an employment dove. That is, he now cares as much about maintaining employment as he does about reducing inflation. 

According to comments from the Fed, we have inflation moving sustainably toward 2%, an unemployment level that, by historical standards, would still be considered low, and a stable real GDP growth outlook of about 2%. 

The fact that the Fed has so far successfully engineered bringing inflation down without causing a credit crunch would seem to continue to support the soft-landing outcome that we’ve been a proponent of for some time. Indeed, our own checklist of economic indicators, including the latest GDPNow forecast for Q3, the payrolls data, the current level of credit spreads, and the performance of regional bank stocks, does not suggest any economic stress is present at this time.

In terms of corporate earnings, the S&P500’s third quarter earnings growth of 11.9% bested the estimated earnings growth of 8.9%, according to FactSet Earnings Insight. Forward earnings estimates have been a pretty good proxy for actual trailing estimates, and they are currently hitting all-time highs with an earnings growth outlook for 2025 and 2026 up 15.1% and 12.4% respectively.

Putting this all together, we think a robust earnings outlook, solid economic growth and lower interest rates is a positive backdrop for further share price appreciation. That said, we could see some near-term volatility leading into the U.S. election. However, beyond the election, if history repeats itself, market performance usually improves, and within the framework we just described, we remain constructive on the market outlook from here.

NORTH AMERICAN EQUITY UPDATE

Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

Our overall equity exposure increased 1% to 97% and cash decreased from 4% to 3%.  Our U.S. equity exposure is 55% while our Canadian equity exposure is currently 42%. For portfolios invested in our North American plus International Equity strategy, the US and Canada weights will be proportionately less than this given the current 20% allocation to international companies.

Over the past 12 months, we continued to shift our allocation in favour of US equities (+13%) over Canadian equities (-10%). US earnings growth continues to outpace Canadian earnings growth, and this is estimated to continue in 2025 and 2026. While we are not calling for a recession in Canada, we do believe the risk of one is higher, with economic growth slower and unemployment higher here than in the US. That said, so far, we have been seeing interest rates decline faster here in Canada than in the US, which may mitigate that risk. 

We added three new positions during the quarter:

Nvidia Corporation needs no introduction, being the leader in the production of graphics processing units (GPUs) that power Artificial Intelligence (AI). We took advantage of the macro-pullback in the market this summer to initiate a position at a now-reasonable valuation as earnings continue to grow rapidly.

Eli Lilly is a healthcare company that has taken the place of Novo Nordisk in our portfolio, in which we had over a 50% gain. While both Novo and Lilly are strong players in the growing diabetes and obesity market, several factors helped make a compelling case for the switch.

Stantec is a global leader in engineering consultancy with a focus on water and infrastructure. With a strong 5-year compound annual EBITDA growth rate of over 20% and record current backlog, Stantec is positioned to continue to deliver strong operating results.

A detailed review of these companies can be found in the full report per the link above.

GLOBAL EQUITY UPDATE

Phil D’Iorio, MBA, CFA
Portfolio Manager, Global Equities

Global equity markets continued their upward climb this quarter. The S&P was up 20.8% over the first three quarters of the year, the strongest such showing since 1997. Key factors that drove markets higher included strong corporate earnings, interest rate cuts around the world, and reduced fears about a global economic recession.

Japan was an exception, with the Tokyo Stock Price Index falling -5.8%. This was partially driven by concern that recent strength in the Yen will weaken Japan’s exporters. However, we do not believe that this will derail the multi-year uptrend in Japan’s equity markets.

In the latest Bank of America Global Fund Manager Survey, 79% said that an economic soft landing is now the most likely outcome. We share this view for a number of reasons. Among them, strength in the U.S. and global economies, stock market gains that are broadening out beyond the big tech names, and an absence of recessionary signals from the bond market.

We believe conditions look steady across most of the major economic regions with China as the notable exception. During his most recent press conference, Fed Chairman Jerome Powell said that the U.S. economy is growing at a solid pace and that inflation is coming down. In Europe, the economy is growing modestly and is expected to improve significantly in 2025. Meanwhile, China’s economy continues to struggle in the face of sluggish GDP performance, sagging consumer confidence, and a collapse in property prices. The country recently announced a series of stimulus measures to lower borrowing costs, inject funds into the economy, and ease the mortgage repayment burden for households.

The lead-up to U.S. presidential elections has historically been associated with elevated volatility in the stock market. While we were spared from the market weakness that typically occurs in September, we’ll be on guard for potential volatility during October. Furthermore, we will be ready to act and take advantage of any opportunities that are presented to us.

In our Global strategy, we established the follow new positions during the quarter:

Amphenol makes connectors and sensors that are used across a wide range of applications. The company’s products are positioned to benefit from secular growth themes including increasing electrification in automobiles, Artificial Intelligence through data centre growth, and the Internet of Things.

Nvidia Corporation needs no introduction as described above, being the leader in the production of graphics processing units (GPUs) that power Artificial Intelligence (AI). We took advantage of the macro-pullback in the market this summer to initiate a position at a now-reasonable valuation as earnings continue to grow rapidly.

In the International strategy, we initiated three new positions:

3i Group is a private equity company with over 70% of its net asset value accounted for by a company called Action, which is Europe’s fastest-growing non-food discounter. Management is currently considering expanding its store base within and beyond Europe, and we believe there is a long runway of growth ahead for Action.

Disco Corp is the dominant semiconductor dicer and grinder equipment provider with market share of 85% and 65%, respectively. Disco is a beneficiary of more than $10 billion in additional semi-conductor backend processes announced by Taiwan Semiconductor and Intel in Malaysia and New Mexico.

Recruit Holdings is a dominant Human Resources Technology company. Recruit is pursuing a long-term strategy to transform its technology from a pay-per-click model to a pay-per-hire model that could expand its total addressable market tenfold to $327 billion and increase its take rate from less than 1% to a significantly higher level.

A detailed review of each company can be found in the full report per the link above.

Yet another good quarter for both the S&P500 and TSX has come to a close. During the third quarter of 2024, the S&P500 total return was 5.89% in U.S. dollars. Adjusting for currency, the S&P500 returned +4.59% in Canadian dollars, as the Canadian dollar appreciated about +0.0084 cents, closing the quarter at US$0.7394. The TSX total return was +10.54% in the third quarter.

The much-anticipated monetary policy easing cycle started earlier this month when the Federal Open Market Committee (FOMC) cut interest rates by 50 basis points (bp) to 4.75%-5.0% as Chairman Powell signaled that he was shifting from being a so called an inflation ‘hawk’ to an employment ‘dove’. That is, he now cares as much about maintaining employment as he does about reducing inflation with high interest rates. To quote the FOMC statement, “the committee has gained greater confidence that inflation is moving sustainably toward 2% (the committee’s objective) and judges the risks to achieving its employment and inflation goals are roughly balanced”. In the latest changes to the FOMC’s Summary of Economic Projections (SEP) released on September 18th, 2024 (Exhibit 1), the unemployment rate for the 2024-2026 period increased to a high of 4.4% while both Headline and Core PCE (the Fed’s preferred inflation measure) moved lower toward its target of 2.0%. Real GDP was essentially held flat from its previous June projection over the next three years at about +2.0% annually.

Market performance for the second quarter of 2024 was mixed as the S&P500 experienced a small gain
while the TSX was slightly negative. During the second quarter, the S&P500 total return was 4.28% in U.S.
dollars. Adjusting for currency, the S&P500 returned +5.35% in Canadian dollars, as the Canadian dollar
depreciated about -0.008 cents, closing the quarter at US$0.7310. The TSX total return was -0.53% in the
second quarter.

Is it possible that the Federal Open Market Committee (FOMC) June projections that reduced the number
of rate cuts for 2024 from three to one are bullish for the stock market? Let’s consider the FOMC’s latest
Summary of Economic Projections (SEP) released on June 12th, 2024 (Exhibit 1). Both Real GDP
Growth and Unemployment expectations for year end 2024 were left unchanged at 2.1% and 4.0%,
respectively, from the March projections (Exhibit 1, blue shaded highlight). This is not surprising given that
the US unemployment rate is going into its third year at or below 4% and real GDP growth as forecasted
by the Atlanta Fed GDPNOW is expected to be 3.0% for Q2 2024, up from 1.4% in Q1 2024 (Exhibit 2).
The Fed did adjust its PCE inflation forecast up slightly from 2.4% to 2.6% by year end (Exhibit 1, yellow
shaded highlight) but recent cooler than expected CPI data suggest that this may be somewhat backward
looking.

In our view, the current market advance is a result of the combination of a strengthening economy, growing earnings and the expectation of rate cuts later in 2024. The market’s focus has pivoted away from concerns about rising interest rates, which facilitated the rally during the fourth quarter of 2023, focusing on the forecasted earnings growth in both 2024 and 2025 (after flat earnings in 2023) which took the markets to new heights in 2024 year to date. Price/earnings (P/E) multiple expansion (i.e.: an increase in what investors are willing to pay for every dollar of earnings) is not unusual at this point in the cycle as earnings estimates catch up. This leads to stock valuations that are higher than historical averages, however with that said, we still don’t believe they are unreasonable for this point in the cycle.

Finally, last week’s update by the Federal Open Market Committee of the U.S. Federal Reserve (Fed), seems to support our expectation of a lower Fed Funds Rate (and therefore lower interest rates) in the second half of 2024.

It seems like everyone in the investment world likes to use sports analogies to describe the current economic cycle and Federal Reserve Chairman Jerome Powell’s actions, which recently happened to be a pivot, generally known in the markets as the “Fed Pivot”. Team Powell has two coequal goals for monetary policy: those are maximum employment and low inflation. Exhibit 1 shows the evolution of the Federal Funds target rate (dot plots) by Federal Reserve Board members and Bank presidents. What was indicated at the Fed’s December meeting, and is confirmed in the charts below, was the “Fed Pivot”. That is, they did not raise rates for a third consecutive meeting but more importantly, the median projection for the Fed Funds target rate was lowered for 2024 and 2025.

Last quarter we discussed the likelihood of a soft economic landing given that economic growth was slowing but likely not turning negative, and the earnings outlook was improving in the back half of 2023 and 2024. Since then, a few positive data points on the inflation front have come in over the summer months to support that hypothesis, and these have been enough to shift market consensus to the soft-landing from recession camp.

It’s hard to believe that the S&P500 and TSX delivered positive returns during the first quarter. After all, inflation is still high, the Federal Reserve (the Fed) continued to increase interest rates in March, consensus 2023 earnings are down almost -12% from their peak and on March 10th, Silicon Valley Bank (SVB) failed -the second largest bank failure in US history. During the first quarter the S&P500 total return was +7.5% in US dollars. Adjusting for currency, the S&P500 returned +7.4% in Canadian dollars, as the Canadian dollar appreciated about 2/10ths of a cent, closing the quarter at US$0.7398. The TSX total return was 4.6%.

2022 was another year of tremendous volatility, although we ended the year with some positive recovery as the S&P500 total return for the fourth quarter was +7.6% in US dollars. Adjusting for currency, the S&P500 returned +6.3% in Canadian dollars, as the Canadian dollar appreciated about 1.5 cents, closing the quarter at US$0.7381. The TSX total return was +6.0% in the fourth quarter. For the year, the S&P500 total return index was down -18.1% in US dollars or -12.5% in Canadian dollars, as the Canadian dollar depreciated -5.3 cents. The TSX total return for the year was -5.8%. To put this negative performance for 2022 in context, recall that in 2021, the S&P500 total return index was up +28.7% in US dollars or +27.5% in Canadian dollars, while the TSX total return for the year was +25.2% and that followed positive returns in 2020 even with the large COVID-19 drawdown in March of that year. As well, the North American Capital Appreciation strategy has managed to do better than the markets over these past two years.

“Don’t fight the Fed”. This phrase was coined in the 1970’s by famed investor Martin Zweig. Here we are approximately 50 years later, and we think the same quote could not be more applicable. At the September Fed press conference, Jerome Powell said that the main messaging has not changed from his speech at Jackson Hole in August 2022. Here are some quotes of what he said then:

“Today, my remarks will be shorter, my focus narrower, and my message more direct”
“Restoring price stability will likely require maintaining a restrictive policy stance for some time.”
“We will keep at it until we are confident the job is done.”
– Jerome Powell

The Fed has made its position clear. Fighting inflation with higher interest rates is a top priority and anyone who assumes otherwise may be disappointed. So…

DON’T FIGHT THE FED!

The S&P500 officially entered a bear market on June 13th after it fell -21.8% from its January 3rd high. Any decline over -20% is considered bear market territory. For the second quarter ending June 30th, the S&P500 total return was -16.1% in US dollars. Adjusting for currency, the S&P500 returned -13.5% in Canadian dollars, as the Canadian dollar depreciated about 2.3 cents, closing the quarter at US$0.7768. The TSX total return was -13.2% in the second quarter. The main cause of the decline was probably the May CPI inflation data pressuring the Federal Reserve (Fed) to increase the federal funds rate by 75 basis points in June shortly after the inflation report.