Technology is Back in a Bull Market.
February saw further gains in the equity markets, with the S&P returning 5.2% and TSX up 1.6% in local currency. The strength in U.S. markets vs. the TSX was due to a strong return in technology stocks, with the NASDAQ Composite Index rising 6.1%, eclipsing its all-time high set back in 2021.
Written by Head of Research, Jamie Murray, CFA
The Recession That Wasn’t There.
Any slowdown in the U.S. economy from higher interest rates appears to be fading. Gross Domestic Product (GDP) for the fourth quarter of 2023 grew at a 3.3% pace, according to U.S. Commerce Department data released in late January. As well, real time measures of GDP indicate that this trend is continuing in Q1/24, with the Atlanta Fed GDPNow tracker indicating a 3.4% expansion based on January data releases. This pace is well above Wall Street economists’ models, as can be seen in Figure 1. We believe there are several reasons for the strength, starting with a rebounding technology sector, a resilient U.S. housing market and declining inflation.
Written by Head of Research, Jamie Murray, CFA
At Tale of Two Markets: 2024 Outlook
If 2022 was the worst of times, 2023 was the best of times. The S&P 500 returned 24% in US dollar terms. The NASDAQ returned an even greater 43%. This was a welcome reprieve as the two indices returned -18% and -33% respectively in 2022. The Russell 2000 Index, which tracks the performance of U.S. small and medium size equities, returned 15%, although all the gains came in the final two months as the index was down 6% as late as October 30, 2023.
To the Victor Goes the Spoils.
The technology sector has outperformed in 2023, as growth and profitability came roaring back following a disappointing year in 2022, when the sector fell 29%. The focus has been on the Magnificent 7 (MAG 7) group of stocks (or 8 when Netflix is included), expanding on the FAANG acronym of 2018, with the group rising ~73% year to date.
Earnings are turning positive. When will stocks do the same?
Written by Head of Research, Jamie Murray, CFA
Bond Math
September continues to be a brutal month for equities as markets fell globally despite data that indicates strong GDP growth in the U.S. Workforce participation rates are normalizing leading to continued gains in employment but also loosening the labour market. This is leading to a slowing of wage growth. This combined with larger output volumes should slow inflationary pricing pressures but also lead to better profit margins. There is still a classic inventory correction recession in our near future once output catches up to the excess demand created during the pandemic shutdown, we would expect this to be the catalyst for the global central banks to neutralize anti-inflation policies. We believe the stock markets of the world will rally on this looking forward to a stabilized productivity driven economy with the opportunity of strong profit growth. In the short term, interest rates will continue to dominate the market narrative.
Markets softened across North America in August as interest rates ticked higher despite a strong earnings season in which profit guidance increases were the highest in two years and there was a good ratio of earnings beats-to-misses.
The future is today.
We believe great returns are made by investing in companies that can scale, where their high-margin products and services can be distributed far and wide to customers, with the intent of creating repeated purchases. Internet technology companies like Microsoft, Alphabet and Amazon fit this bill, and this is the primary reason we have been comfortable holding them through such a challenging economic environment. The Internet provides a low-cost distribution medium and the platform business model allows for repeat usage by facilitating valuable exchanges across an ever-larger number of participants. As usage grows, profits can scale quickly. It is up to the business to continue the innovation of new products to deepen its moat around the platform, either by increasing output or reducing costs. For example, Amazon can deliver most household products at a faster speed and/or lower cost than other retailers due to its delivery network. It continues to build this service (and its value) through even faster delivery times for the same cost. Technology companies were by far the strongest performers in the month of May and have bolstered their year-to-date return to 32% (Figure 1). Their performance can be attributed to increased interest in artificial intelligence (AI), particularly generative AI, whereby new computer outputs (be it software code, imagery, text, or grocery lists) can be created by the AI program.
Earnings season is in full swing, with hundreds of companies reporting quarterly financial results. These reports are a valuable tool to gain insights into a business or industry, benchmark a company versus its peers or test whether an investment thesis is working. However, some investors tend to place excessive importance on a single earnings report, mischaracterizing the strength or weakness of a company’s short-term financial performance as durable, missing the cyclical or temporary factors that may have caused the earnings surprise, and failing to understand the principle of reversion to the mean.
A banking crisis or a bank crisis?
The failure of Silicon Valley Bank (plus Signature Bank of NY) in March 2023 and the subsequent panic brought back shades of 2008 and Bear Sterns’ collapse in March 2008. At that time, it was known that certain assets held on the books of financials were challenged, with many sub-prime and asset-backed securities incurring elevated losses as early as February 2007. It would be another 6 months post-Bear Stearns for the banking collapse to come to fruition, with the fall of 2008 providing the climax of risk. Read
Market churn continued again in February with the market giving back about half of January’s gains. The price action in the world of equities over the past year can be seen in the following chart of monthly returns for the S&P500 Index. Read
The world is convinced a recession is coming.
Flashback to September 30, 2022. The S&P 500 was down 25% year-to-date. European power prices had doubled in a year. U.S. inflation was running at 8.2%. The Federal Reserve and other major banks were in the middle of an interest rate hiking cycle to curb economic growth.
Four months later, the U.S. economy just added 500,000 jobs. Inflation is retreating from high levels and central banks are indicating that a pause in hikes is forthcoming. Yet a recent survey of economists by J.P. Morgan indicates that recession calls (defined as probability of a recession in the next 12 months) are at all-time highs (Figure 1). A secondary indicator, the AAII Bulls/Bears survey indicated 30% of investors are bullish, compared to an average level of 37%.
Figure 1. J.P. Morgan Survey of Professional Forecasters.
We close the door on yet another year and thank our clients for your continued trust in The Murray Wealth Group. The Global Equity Growth Fund had disappointing performance in 2022, declining 15.8% as rising interest rates squeezed the P/E multiples of quality growth stocks. However, our Income Growth Fund recorded positive performance of 2.9% and outperformed its benchmark by 1,010 basis points. Please see our portfolio review section below for full details.
Have long-term rates peaked?
As inflation surged in early 2022, central banks around the world began raising interest rates to slow economies and combat higher prices. We will focus on the United States and The Federal Reserve (the ‘Fed’) in this report as the U.S. dollar is the world’s reserve currency, and thus, the Fed’s policy is the most influential on financial markets. The rise in overnight rates (known as the Federal Funds Rate) from essentially nil to 3.78% has been the sharpest in absolute terms in the past twenty years and is even more dramatic when considering the effect of duration* in a low interest rate environment (Figure 1). Fed Governor Jerome Powell is planning additional increases to bring the rate above 5% in 2023. Read
Our position at the beginning of this year was that mega-cap technology companies would be relatively insulated from the economic effects of 2022. As we wrote in our 2022 Outlook, we were of the opinion that revenue would still increase off a large base after accelerating through Covid. Moreover, we felt that capital spending could be reined in on low-priority projects, allowing sufficient free cash flow to support stock prices through share buybacks. As well, valuation multiples were in line with the prior decade, and we felt that balance sheet flexibility would act as a buffer to weather any downturn. Read
Volatility remained high through September, with the volatility index ending the month at 31, nearly double the 17 level it closed the year at in 2021. V Volatility will remain high until it isn’t, which is an obvious statement in itself, but by the time the “all clear” signal is out, the market will be meaningfully higher. We continue to monitor our portfolio companies closely and believe their financial performance remains strong.
Never let a good crisis go to waste.
Russia has now shut off gas to Europe (figure 1). The timing could not be worse as it follows a summer of heat waves and droughts as well as a large French nuclear power maintenance cycle. It is clear that Putin is trying to tighten the financial noose around the West and equally clear that his strategy is having an impact as protests erupt in Europe over rising electricity costs. Europe has attempted to front run the shut-off by limiting industrial usage and buying every LNG cargo available (LNG imports were up 190% year-to-date through July 2022). Read
Written by Jamie Murray, CFA
We wrote last month that after the worst start to a year in half a century, positive data points on the equity markets were transpiring. You can re-read the argument by clicking here. At the time, contributors to supply side shortage reversals included falling energy and commodity prices, easing of the semiconductor shortage, lower shipping costs and falling bond yields. One month later, markets have further improved on all fronts. Read
Written by Jamie Murray, CFA
Volatility continued in May, with markets falling as much as 7% in the first 11 days of the month before rebounding by month-end.
Markets fell sharply in April. There’s a lot to cover… Read on!
Written by Jamie Murray, CFA
We wrote in the past about the 2000 technology bubble and the similarities and differences between today’s companies and the tech giants of 2000. To summarize, many companies caught in the 2000 bubble, such as Cisco (or Nortel) and Oracle, were reliant on high value one-time sales. These firms sold an abundance of technology products or software into the Y2K/fibre networking/ internet revolution, only to see demand exhaust itself and product sales decline. Both Cisco and Oracle’s sales were 16% lower in 2003 than they had been in 2001. Even Yahoo, whose model focused on advertising more akin to Alphabet or Facebook, experienced a fall in revenue of 44% in 2001. Yahoo had traded at a $120 billion dollar valuation near its peak (120x revenue). For comparison purposes, Cisco and Oracle traded around 22x and 17x revenue. Today, those numbers are 4x and 6x, respectively. Read
Is this peak inflation?
Inflation, and the Federal Reserve’s response to its economic threat, has been the dominant driver of financial markets for the past five months, culminating in the Personal Consumption Expenditures Price Index (PCE) reaching a 40-year high last week. There are numerous drivers for this: housing/rent increases, shortages of durable goods (from autos to air conditioners), decade-high energy and commodity costs, supply chain bottlenecks and labour shortages. In response to the inflationary threat, the Fed has committed to a rapid succession of interest rate hikes to rein in prices. Read
Markets Fret the Three “In’s”: Inflation, Interest Rates and International War
Written by Jamie Murray, CFA
The escalating war in Ukraine has roiled capital markets with swift sanctions, exacerbating supply challenges. Keep in mind, the Russian economy is insignificant on the world stage, accounting for ~1% of global GDP. A company such as Mastercard has likely lost its revenue from the region (forever) but the 2% hit to its revenue will soon be forgotten as the rest of the world continues to move to digital currency. The upshot is the inflationary effects of higher energy and commodity prices. Commodities, including wheat, oil, European gas and nickel, reached decade-high levels in early March as the West quickly shut off trade with the country.
2022 Market Outlook
Written by Jamie Murray, CFA
Following a busy January around MWG headquarters (and several rewrites), we present our 2022 outlook in conjunction with our January Portfolio Update. January 2022 was the month “Buy the Dip” died; it was a strategy that had worked endlessly for three years save for the COVID-induced drawdown in March 2020. Both selloffs penetrated the negative 10% levels. Equities did recover off their lowest levels, thanks to two strong days back-to-back to close out the month. Bonds also fell in January, with a 4% fall in the 20-year Bond ETF. There were few hiding spots beyond value stocks.
We wrap 2021 with another outstanding year in the equity markets. In U.S. dollar terms, the S&P 500 rose 27%, building on a first half return of 15% with a 10% return in the second half of the year.
Equity Market 3-peat
Markets are chugging higher as we write in between some brisk selloffs in those sectors with cyclical underpinnings. Despite the volatility, the benchmark S&P 500 is up 25% YTD through November 30th. 2021 will go down as another stellar year in the equity markets, a 3-peat considering the double-digit gains in 2019 and 2020. Read
Do your holiday shopping early unless you’re buying on Amazon.
The world’s supply chains are plugged up. This isn’t new. Nike warned in March 2021 that container shortages and port congestion were delaying shipments of goods, and the situation has only deteriorated since then. Fortunately, brands like Nike and Aritzia that sell DTC (direct-to-consumer) can offset these challenges with increased sell-through at full prices given the scarcity of product. One advantage of online stores is their ability to show the customer the lack of stock or lead times for an item. As shown in figure 1, Aritzia can essentially pre-sell items, which is also a big boost to its working capital. Read
Markets go up, Markets go down.
We are currently in the midst of a minor correction, with the S&P 500 down 6% from its high on September 2, 2021. This is the first test for investors since the since the fall of 2020, when the market sold-off 9% ahead of the U.S. Federal Election. The tweet below from finance writer Morgan Housel sums up our feelings more eloquently than we could. Read
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