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When we meet clients and express optimism about the markets, some might think we're just saying that because it’s our job. That's simply not true. We do tend to be positive, just like the markets are mostly positive, but our views are always dependent on data. Markets often trade on emotion, and our role is to help you rationalize and spot opportunities in times of uncertainty. So today, let’s update the data. It’s time for a mid-year economy's health check.
Hi my name is Philip Petursson,
Economic surprise indices have trended lower this year. In fact, macroeconomic is mixed across the board. One of the reason is that the consumers are split into two groups: high-end consumer strength and lower revenue weakness. Inflation explains this split: lower earners spend a larger share of their income on essentials like food and housing, which are most affected by inflation. They also lack investments, either real estate or savings, that grew in value during the last few years. This combination makes inflation particularly challenging for those with the least financial flexibility.
People who had assets before the Covid crisis have seen their net worth increase, while renters and those without savings have seen their spending power crushed. Inflation hits hardest on those with the least. This translates in the stock market as conflicting commentary from companies, some calling the U.S. consumer strong and others sounding the alarm.
It also shows up in employment. In Canada, the unemployment rate is now 6.2%, above pre-Covid levels and more than 1% higher than the lows of 2022. The U.S. is seeing a similar trend, with unemployment at 4%, also above pre-Covid levels. While these rates are historically low, the trend isn’t positive. The economy largely relies on consumption; as long as people have money, they will continue to spend, driving economic activity. However, rising unemployment and inflation can reduce disposable income, thereby weakening overall consumption and slowing economic growth.
Despite these challenges, companies are still growing their earnings. Year-over-year earnings growth is 4%, driven by improvements in earnings per share, not just comparisons to a weak previous year. While margins are improving, sales growth is definitely slower. So, who is making money in such an environment? The winners are the usual suspects: quality large-cap companies. Small caps are underperforming and reaching new lows in relative performance against the index. They are more affected by interest rate increases. However, before you think that they are in a great position since rates are likely to fall this year, remember they also need a strong economy to thrive, which seems unlikely in the near term. They could in fact be hurt both ways.
This doesn’t mean stocks can’t perform. We recommend trusting your asset allocation. You want exposure to high-quality companies with growth features and defensive companies. Stocks that can provide strong returns even in uncertain economic times due to their robust business models and innovative capabilities. These are found in the U.S. You also want defensive companies, like utilities, as they offer stability as they tend to perform well regardless of the economic cycle.
On the other hand, you also want exposure to Canadian materials and energy companies, which tend to do well in late cycles. These sectors often benefit from increased infrastructure spending, which are likely in the years ahead for factors that go beyond the economic cycle. And yet, you can’t dismiss the financials and the consumer discretionary stocks you will find in your international stocks. There are reasons to believe that international markets have actually improved their growth prospects. And of course, your bond portfolio is there as your last line defender. As you can see, diversification is key.
Data suggests that there are some warning signs in the economy. It doesn’t automatically mean that this will translate to market weakness, but making sure the portfolio is well positioned is key. When it comes to looking ahead, we hate to use the words “cautiously optimistic,”… so instead we will say: “optimistically cautious.” |