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THIS WEEK WITH SADIQ

When Will Cash Come Off the Sidelines?

June 10 to 14, 2024

Weekly Commentary

Interest Rates

Last week, in a much-anticipated decision, the Bank of Canada (BoC) lowered its key interest rate by 25 basis points—a move that was mirrored a day later by the European Central Bank (ECB). Market participants were on the bubble about the BoC’s decision, but as I mentioned in this space last week, we were confident it would happen. Overall, market reaction was relatively muted. The Canadian dollar (CAD) did drop somewhat before bouncing back. Canadian equity markets were also up, but so were U.S. and International exchanges, so the rise likely is not attributed to the rate cut. We anticipate the market’s reaction to get more pronounced as more rate cuts come through—and we do expect more cuts. The CAD is likely to continue to weaken as rates are lowered and the gap with the U.S. Federal Reserve’s (Fed) policy rate widens. On the other hand, rate cuts should be a positive for the Canadian bond market, especially relative to U.S. bonds. Looking ahead, the BoC highlighted that more rate cuts are likely coming, but also emphasized that, like their American counterparts, they’re still data dependent. That gives them an out if they feel they’re getting too far ahead of the Fed, or if an unexpected data point pops up. The ECB took a similar stance in its statement but was less definitive about future cuts. The reality is that in both Canada and Europe, the inflation picture is very different than it was 12-18 months ago, and rates at that level are simply no longer appropriate.

Bottom Line: The BoC’s first rate cut of this cycle was a positive sign for markets, and we expect more cuts moving forward.

Elections

Since the beginning of the year, we’ve believed that certain geopolitical risks were not fully priced into markets, and that they could cause volatility. Recently, we’ve seen that exact scenario play out after major elections in Mexico and India. In Mexico, news of Claudia Sheinbaum’s election as president wasn’t greeted warmly by markets, with the Peso and equities both dropping. In India, prime minister Narendra Modi won re-election, but failed to capture a parliamentary majority as most had predicted. With a minority government, it will be harder and slower for him to pass his policy proposals, and that uncertainty is likely what caused some gyration in the Indian stock market. This doesn’t change our overall view on India, however—we still think the long-term growth fundamentals are strong, and we continue to anticipate increasing our exposure to India within our Emerging Markets allocation. A similar dynamic can be anticipated with the upcoming U.S. presidential election. Whether Biden or Trump wins may influence our allocation to particular sectors or geographies, but we think it’s unlikely to change the overall trajectory of U.S. markets.

Bottom Line: Elections often have a short-term impact on markets, but they rarely warrant a long-term shift in positioning.

Equities

Equity markets have continued to rally this year despite a cooling economy, and some analysts have speculated that a “wall of money” from money markets and cash equivalents will pour into passive equity allocations this summer, creating yet another tailwind. We suspect that it could take longer—the summer months tend to be a quieter period for trading, and there is also the U.S. election to consider. It’s true that there is lots of money on the sidelines, but in our view, investors may prefer to let the dust settle before jumping back into the stock market with both feet. They may also need to see multiple rate cuts from the Fed before their confidence is fully restored. When the time is right, conservative investors are likely to shift from cash to bonds or conservative equity portfolios, while those with a higher risk tolerance could seek out more balanced strategies. With Canada having already cut interest rates and a U.S. rate cut likely down the road, money sitting in cash is a virtual lock to come back to markets in some form. It just may be in the fall or winter rather than the summer, with a rate cut from the Fed unlikely until September or October at the earliest and the election set for November.

Bottom Line: Given uncertainty around rate cuts and the U.S. presidential election, we think investors might wait a bit longer before fully returning to equity markets.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled The Fed’s Last Stand: A Solitary Rate Cut Expected for 2024.

Market Update

Equity markets churned out gains this week alongside firm U.S. economic data and rate cuts by the Bank of Canada and ECB.

The S&P 500 rose 1.3%, led by technology and health care, although the Roaring Kitty hoopla sapped most of the attention. The index closed the week just off a record high, along with the Nasdaq, and is now up a cool 12.1% on the year.

The TSX slipped 1.2% on the week, with energy and materials dragging against gains in consumer stocks, technology and telecom.

Photo of Sadiq S. Adatia Photo of Sadiq S. Adatia
Sadiq S. Adatia FSA, FCIA, CFA, Chief Investment Officer

Mr. Adatia joins BMO from Sun Life Global Investments, where he most recently held the role of Chief Investment Officer. Prior to that, he held investment roles at Russell Investments Canada and Mercer Canada. He holds an Honours Bachelor of Mathematics degree in Actuarial Science & Statistics from the University of Waterloo. He is also a CFA Charterholder and is a Fellow, both of the Society of Actuaries (Investment Specialty Track) and the Canadian Institute of Actuaries.

Monthly perspectives

Equities

Neutral

Fixed Income

Neutral

Cash

Neutral
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Asset Mix

  • We downgraded equities to neutral this month as we think sticky inflation fear and delayed cuts from the U.S. Federal Reserve (“Fed”) could turn into headwinds for equities this summer.
  • We increased fixed income back to neutral and we are now neutral across our asset mix between stocks, bonds and cash.

Canada

Slightly Bearish

U.S.A.

Slightly Bullish

EAFE

Neutral

EM

Neutral
Read more

Equity

  • Our regional equity mix remains unchanged this month.
  • We remain underweight to Canadian equities.
  • We prefer to be tilted toward U.S. equities with its bias for higher quality and benefit from the far more robust U.S. economy.
  • We expect the Canadian economic outlook to continue to soften in 2024 as rate hikes are weighing on the economic outlook and the loonie.

IG Credit

Neutral

High Yield

Neutral

EM Debt

Neutral

Duration

Neutral
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Fixed Income

  • We remain neutral across fixed income as the near-term outlook for monetary policy remains uncertain regarding the timing and amplitude of Fed cuts.
  • The Bank of Canada could be hesitant to ease policy more than is expected by markets, which could limit the upside from duration.
  • Overall, the stronger U.S. growth outlook could threaten the improving inflation outlook, which leaves us neutral on duration for now.
  • We increased our bullish view on gold as a hedge against the risk that long-term interest rates might continue to drift higher or if the U.S. economy was to cool faster than expected.

Value

Slightly Bullish

Volatility

Slightly Bearish

Quality

Slightly Bullish

Yield

Slightly Bullish
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Style/Factor

  • We continue to prefer higher quality companies who enjoy stronger balance sheets and pricing power, which enables them to have more resilient and wider profit margins.
  • We remain bullish on firms which can improve and deliver strong dividends as interest rates are likely to decrease in 2024, albeit modestly; we expect investors to rotate in favour of that sector this year.
  • We upgraded our view on value companies to a moderate stance as we expect sticky inflation fear to favour value-oriented companies.
  • We remain bullish on low-volatility companies to better navigate a potentially more volatile equity market as Fed rate cuts are delayed.

Canadian Dollar

Slightly Bearish

Gold

Bullish
Read more

Implementation

  • We continue to like gold as a hedge against downside macro risks.
  • We think gold could continue to shine if investors were surprised with renewed recession fear or inflation anxiety which could lead to further delaying expectations for Fed rate cuts and re-ignite a risk-off U.S. Dollar rally and weigh on the loonie.
  • Several central banks are steadily increasing their allocation to gold as a share of their international reserves, which is helping boost demand for gold.

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For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

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