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.

Between rampant inflation due to rising commodity prices, rising interest rates, companies issuing negative earnings guidance and the tragic situation in the Ukraine, there is a lot to be concerned about. We should probably throw COVID-19 in there as well although it’s now one of the further things in investors’ minds.

The good news, from a stock market perspective, is that returns were even better in 2021 than 2020. The bad
news is that as we write this family and friends are being exposed to and/or falling victim to Omicron, which
may have a basic reproduction rate (R-value) as high as 10, far exceeding earlier variants and second only to
Measles.