The US election takes center stage over the summer.
Quarter in Review: A Strong First Half to 2024
As hard as it is to believe, we have crossed the halfway point of 2024. The second quarter of the year saw major asset classes broadly continue higher, albeit with less velocity than at the start of the year. Regardless, it has been a strong first half of 2024 for equities and commodities, with world equities up 12%, led by the US, where the S&P Composite is up over 15%. Commodities are up over 11% as well, reflecting increasing optimism about economic activity.
As seen in Chart 1 below, for the second quarter of the year, global equities were led by the US & Emerging Markets, with Canada and EAFE equities being slight detractors. Canadian fixed income was positive, as the Bank of Canada went ahead with their first rate cut during the quarter. Commodities were broadly higher, while crude was down slightly.
At the sector level, however, we did see a weakening in the breadth, as only 4 sectors of the 11 were positive for the quarter, compared to 10 of the 11 positive in the first quarter of the year. Technology and Communication Services continued to lead the way, while consumer discretionary and materials sectors lagged.
We began to see a change in monetary policy regimes during the quarter, with the EU, Germany, France and the Bank of Canada cutting interest rates during the quarter. After a period of developed economies being in a holding pattern, this change could lead to divergent policy paths, which present implications for portfolios. We will touch on this more below.
Chart 1: Asset Class Returns for Q2 of 2024
Looking Ahead: Three Areas of Importance
- Possible Monetary Policy Divergence
Since the interest rate hiking cycle began in 2022, the developed economies of the world had been relatively in sync with their moves, as interest rates broadly moved up in the fight against inflation. However, in June, Canada, Germany, France, and the EU were the first of these developed economies to change their policy regime and begin to lower rates. This has introduced the potential for diverging monetary policies, particularly against the US, which looks to be on firmer economic footing, and as such less likely to lower rates.
When looking specifically at Canada and the US, is it worth noting that Canada was the first to move. For Canadian investors, this does have implications, particularly related to the foreign exchange rate. A weaker Canadian currency versus our largest trading partner is actually inflationary, as we essentially import inflation into our economy.
We would argue that a potential divergence is warranted, when looking at the relative performance of strength of the two economies. This can also been seen in Chart 3 below, where forward twelve month earnings estimates of the S&P 500 versus the TSX have rebounded to much stronger degree, indicating that expectations are for much stronger growth from US companies.
All this being said, it is far too early to say that diverging policy is occurring. While the odds of a move to lowering rates in the US continues to be moved out due to sticky inflation, some economic signs are indicating that the US consumer is running low on savings and their aggregate demand may be reducing.
Chart 2: US and Canada Policy Rates. Are we seeing a possible divergence between the two countries?
Chart 3: US & Canada Forward Earnings Expecations
- US Election
We are rapidly entering the critical stages of the US Election cycle. After a very poor showing at the recent Presidential Debate, polls are moving more in favour of Donald Trump re-taking the White House. There is plenty of discussion around if or should President Biden continue in the race, or withdraw his candidacy in favour of another nominee from the Democratic Party.
Chart 4: US Election Poll. We can see the change following the recent debate.
Chart 5: Election Polls for key swing states show Trump leading over Biden in the majority
Chart 6: University of Michigan Consumer Sentiment Survey shows sentiment weakening, which is typically bad for the incumbent.
The current uncertainty around President Biden’s continued candidacy does introduce some extra volatility around predicting the outcome of the election over the summer months, which could provide shorter term volatility to financial markets. We have positioned portfolios to be able to take advantage of any dislocations that could present themselves over the summer months and leading up to the election.
It is still too early to draw firm conclusions as to where this election cycle will go, but the coming months will be very informative to that end. Whoever wins in November, they will be leading a global superpower in a time of high geopolitical tensions, both at home and abroad.
- Where do Geopolitical tensions go from here
We continue to operate in a world where there remains elevated geopolitical risks that exist. The conflicts between Russia & Ukraine, and Israel & Hamas continue, and how these are ultimately resolved can be very important for financial markets and the global economy. Further escalations on either front have the potential to hinder the global economy and would likely cause a reset in financial markets.
While we touched on the US election above, there was far more than just the US election this year. We have seen election victories for right-wing political parties in Europe, most recently in France and Italy, while at the time of writing the UK Conservatives were handed a significant defeat by the Labour party after quite a long time at the top of UK politics. We continue to see more polarization in Western societies, and as a result the democracies of those countries follows suit. Key issues such as inflation, jobs, and immigration policy have become decisive issues for voters globally. Given that we are operating in a time of geopolitical tensions, changes to government need to be considered amidst the backdrop of how they plan to operate on the international scene, and not just domestically.
In Summary
In summary, it has been a strong start to the year, particularly in US and world equities. Given the potential uncertainties around the US election and continued geopolitical tensions, we continue to remain prudent in our portfolios, keeping a close eye on position sizing both at the individual investment and asset class level, and continue to believe in having cash available to take advantage of opportunities and dislocations that may arise over the summer months, as we anticipate a pickup in volatility. We do expect short term rates, particularly in Canada to continue to lower, and that should allow for fixed income to be a buffer in portfolios.