The final quarter of the year features continued geopolitical hotspots, amid a US Election.

Quarter in Review

The summer months came and went in a flash. Broadly speaking, it was another fruitful quarter in financial markets, with broad based gains across equities and fixed income.

While July saw a pullback in the leading equity sectors of technology and communications services, it was solidly contained to those sectors and for that month, and the remainder of the summer saw broad strength. As interest rates begin to fall, it has provided a boast to valuations and flows to the financial, real estate and utilities sector, as higher yielding companies began to appeal to income orientated investors once again, as yields and expected returns in fixed income began to fall.

Broad-based commodities were a weak spot in global markets, as energy prices fell on the back of lower expectations for demand. As tensions rose in the Middle East again over the last few weeks, energy prices have begun to show a bit more life, and, coupled with a significant stimulus package emanating from China, commodities have looked a little stronger as of late, albeit with some enhanced volatility as markets try to value and price in the effects of these datapoints to the overall demand story.

We also saw a few significant ongoings in North American politics. While we will touch on this more below, the quarter featured the replacement of the Democratic nominee for President, with President Biden electing not to run in this November’s election. He has been replaced by Vice-President Kamala Harris, and with it, a curveball has been thrown with respect to the US election. Closer to home, the big news item was the withdrawal of the NDP from the supply and confidence agreement that was allowing the Liberal minority government to govern. This withdrawal has thrown uncertainty and unpredictability into if this current government will remain in power until an election next fall, or if Canadians will be electing a new government sooner than expected.

Chart 1: Global Asset Returns for Q3 2024

Looking Ahead: Three Areas of Importance

In our view, there remain three key areas that will drive the headline noise and news flow and have the ability to move markets and sentiment. Those are: domestic politics and elections, geopolitical escalation, and the changing monetary policy regime.

1. Monetary Policy

Let’s start with the later. The central bank cycle has been and is shifting from raise rates to holding rates steady, to now entering a cutting cycle. In this, Canada and others were ahead of the US, with Canada now having cut 25 basis points three times, while the US Fed delivered a widely expected 50 basis point cut in September. Even though this move had been expected and priced in by markets, it still marked a regime change for the largest central bank in the world, and that is noteworthy.

We do believe that inflation, while decreasing, remains a sticky and that is a key measure to watch over the next year with respect to how deep the cutting cycles for central banks can go. This is especially true for the US, whose economy, while slowing, is still expected to exhibit growth. We have seen good jobs reports in the US recently cause the back end of the yield curve to rise, while expectations at the short end of the curve continue to price in consistent 25 basis point cuts into next year. With continued risk of escalation in the hot wars globally causing commodity price shocks, particularly in energy, it is in our view not a given that the Fed will be able to continue to lower interest rates without causing a rebound in inflationary pressures in the economy.

Chart 2: Canada & US Inflation Data

Chart 3: US & Canada Yield Curves. Pink (most recent line) shows how yields have fallen over past year

In the medium to long-term, we continue to see and expect a continued normalization of the yield curve, as it has already begun to un-invert, outside of the very short end of the curve. However, should inflation and the economy prove stronger than expected, there remains the possibility that yields across the curve could be higher than expected, which would cause assets the reprice this outcome.

2. Elections

With respect to domestic politics, the US election cycle is reaching the later innings, and the North American news cycle is dominated by this event, and markets are continually evaluating and pricing in different outcomes. We have long said that ultimately, businesses, large and small, are concerned with operating their business, regardless of who is President, but certainly policy can help us evaluate positioning within the portfolio, and how certain industries may have an easier or harder time operating and growing their business in different policy environments. With a month to go before Americans go to the polls, the result could go either way at this stage.

Chart 4: US Election Polling Data

Chart 5: Key Election Swing State Polling

The larger point is that the polarized society, in the US and frankly across much of the Western world, is not going to go away regardless of who wins, as we don’t believe either candidate is one who can or will build bridges and do meaningful good to mend the division in the US.

With respect to Canada, the NDP pulling out of their supply and confidence agreement raises the possibility of an earlier election that next fall. While the initial non-confidence motions attempted by the federal Conservatives have not passed, it will likely be difficult for the Liberals to govern effectively, and this raises the chances of an earlier election.

In Europe, we continue to see more anti-immigration and nationalist candidates and parties gaining share in their respective countries. This was seen in Italy, France and Germany this year, 3 of the largest and important European economies. In fact, in September Germany announced they were locking down their land borders and tightening up on immigration for a period of 6 months, after a more anti-immigration party won considerable share in elections in important areas of the country.

3. Where do Geopolitical tensions go from here

On the geopolitical front, we have spoken at length in previous editions about the areas of both hot and cold conflict throughout the world. We have recently seen the war in the Middle East take on some new dynamics, with Israel having some large successes in targeting and attacking key personnel and leadership of Hezbollah, who is a powerful force in Lebanon, and another key Iranian proxy. This has returned a bit of geopolitical risk premium back into oil markets. While all eyes remain focused on the Israel/Palestine/Iran Proxy conflict, any major change in the fortunes of Ukraine versus Russia should not be discounted, as we would expect Russia to remain expansionary should they achieve a more decisive victory in Ukraine, which will continue to enflame NATO nations and other European powers, which would certainly cause some risk-off behavior in global markets. One of the key priorities for the new US President upon election will be how they perceive and proceed on these two fronts, as well as with China.

In Summary

As we enter the final months of 2024, the US election, and geopolitical conflicts will take center stage. We remain very happy with how our portfolios are performing, and how they are positioned. We remain prudent around risk management, reducing positions as warranted and monitoring risk at a security, as well as portfolio level.

Within fixed income, as rates have fallen, we have seen gains in individual bond pricing. The fixed income sleeve of the portfolio began to contribute positively to portfolio returns. We continue to lend and invest in high-quality issuers where we can earn a reasonable return. We have extended duration slowly, both through re-investing maturities out as well as tactical government duration. We are pleased with how fixed income has performed in portfolios, and continue to believe that as we proceed in this higher rate environment, bonds has a whole will be able to be a far more productive building block in portfolios.

Equities continue to be main driver of portfolios, with an emphasis on US equities. As seen in the chart below, earnings expectations and growth for developed markets continue to be led by the US. Canada as a whole continues to be challenged, where we believe that pockets of Canada remain of interest. We expect our focus on dividend paying investments to be beneficial, particularly in a falling interest rate environment, as the relative appeal of dividend streams increases versus lower fixed rates of return.

Chart 6: Forward Earning Expectations

Within the alternatives sleeve, we continue to build and maintain a high quality collection of investments, spanning multiple categories, including direct lending, private credit, private equity, commodities, real estate, and liquid options income pools. Our goal, as always, is to use alternatives to reduce the overall risk of portfolios, and provide uncorrelated return and income streams to complement the listed assets comprising equities and fixed income.

In conclusion, we expect there to remain headline risk and noise stemming from the US election, as well as global conflicts in the last months of 2024. Our portfolios are positioned to preserve capital, and we also remain on the lookout for dislocations that allow us to invest in great businesses or high-quality assets at attractive prices.