Thoughts on the Market: July Edition
Written by Head of Research, Jamie Murray, CFA
The Global Recession Probably Isn’t Here Yet
The S&P 500 closed near its all-time high set midway through the month-to-end July trading just as many Canadians were heading to their cottages for the Civic Holiday. The first week of August was then quite a whirlwind. To kick off the month, global markets had their worst 3-day run since 2022. The Japanese market alone closed down 12% on Monday, August 5th. Panic appeared to be taking hold before the modest rebound that followed.
The culprits seemed to be threefold: 1) concerns that the U.S. Federal Reserve is behind the curve on rate cuts, 2) a surprise Japanese interest rate hike that led to an unwinding of the yen carry trade, and 3) a weak jobs market.
The Fed has a dual mandate, to target both low inflation and full employment. Its efforts on the inflation front yielded a 3.0% change in CPI in June 2024, the smallest gain in three years. We noted the weakening jobs market in our June “Thoughts on the Market” piece, with the caveat that labour was moving from very tight to balanced (the unemployment rate in the U.S. still low at 4.3%). However, certain interest rate sensitive sectors like real estate and automotive sales are feeling the pinch from rate hikes. While the job market is swaying negatively with a weakening jobs outlook, the window for rate cuts is still open, with the first rate cut widely anticipated to be announced at the next Federal Reserve Board meeting in September.
Figure 1. A September rate cut of 25 basis points is a near certainty with potential for 50 basis points depending on economic data through mid-September
We believe the window is still open because there are indications the U.S. economy continues to grow:
- Atlanta GDPNow’s initial forecast for U.S. Q3 GDP growth is 2.9%
- Mastercard spending data in July in the United States showed 6% growth
- Uber CEO highlighted that its consumer trends remain healthy and stable, with no trade down effects across any of its income cohorts
- U.S. gasoline demand set a record high for the month of May
However, warning signs are flashing. Shares in leading travel and restaurant companies are pulling back sharply, citing consumer fatigue and the possibility of lowering prices to stimulate demand. Industrial equipment markets are also slowing, with inventory rising at companies like General Motors and John Deere. Technology shares have also sharply reversed on concerns that AI revenue will not materialize as quickly as expected. We argue that there are many early indicators that point to AI investments achieving strong returns, but the risk that AI-related spending could slow is another potential source of downside for the economy.
Canada has now cut interest rates twice, with bank economists expecting additional cuts through year end. The U.S. Fed would be wise to follow suit.
GLOBAL EQUITY GROWTH FUND
The MWG Global Equity Growth Fund rose 2.3% in July, below the 3.6% rise in its benchmark. Year-to-date, the Fund has returned 20.2% versus the benchmark return of 18.0%. The Fund’s top three performers in the month were Raytheon (+18%), Aritzia (+17%) and UnitedHealth (+14%), while Air Canada (-11%), Uber (-10%) and Eli Lilly (-10%) were the biggest detractors.
Portfolio Managers Summary
The market finally broadened out in July, with the forgotten 493 stocks in the S&P 500 handily outperforming the Magnificent 7. Interest rate declines helped rate-sensitive companies, and we saw a number of laggards play catch-up in the health care sector, where our holdings in Thermo Fisher and UnitedHealth hit 52-week highs. We believe the technology trade has further legs but expect the market to consolidate after 18 months of outperformance. We believe AI technology is in early innings, with a strong growth outlook through 2030. Meta Platform’s strong results helped validate that AI capabilities can enhance revenue growth.
During the month, we initiated a small position (1%) in Lululemon Athletica. Lululemon is a company we have long admired, but we could not wrap our heads around paying 40x P/E for an activewear fashion brand. However, the shares have fallen over 50% this year, to the point where we are comfortable paying a below market multiple for what we believe is a staple in the fashion world. Investor concerns surround its maturity in North America but fail to consider its high growth opportunity internationally. We believe that the company has a superior technical product versus upstart competitors and that investing in it is derisked by the $2B net cash on its balance sheet.
INCOME GROWTH FUND
The MWG Income Growth Fund increased 6.6% in July, above the 5.1% increase in its benchmark. The Fund is higher by 10.4% year-to-date versus the benchmark increase of 14.3%. Cogent Communications (+26%), European Residential (+18%) and Blackstone (+17%) were the top performers, while Gibson (-3%), BP (-1%) and Rio Tinto (flat) were the top detractors. The fund yield was 6.5% at month end.
Portfolio Managers Summary
The stars aligned for the Income Growth Fund in July 2024. Interest rate cuts are translating into lower dividend yields. This has the added benefit of lowering borrowing costs for companies that typically rely on higher debt loads to finance their mature operations. Earnings have generally been strong for most of our holdings, with opportunities existing in real estate firms that are seeing sentiment bottom while interest expense peaks and cash flow grows. REITs offer the added upside in that many are trading below the market value of their properties, thus providing additional upside when they are able to execute a property sale transaction, which we saw with European Residential in July.
This Month’s Portfolio Update is written by our Head of Research, Jamie Murray, CFA.
The purpose is to provide insight into our portfolio construction and how our research shapes our investment decisions. As always, we welcome any feedback or questions you may have on these monthly commentaries.