Episode 99: Gearing up for the final stretch of 2024—Market Insights Monthly special edition

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Kevin Headland

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Macan Nia

We think Mid-caps are perhaps that unloved sweet spot in the middle there. Perhaps they're the ugly duckling in this story.

Macan Nia

Good day. Thank you for joining us on our Market Insights monthly webinar series. My name is Macan Nia and I'm joined here with Kevin Headland. Kevin and I share the responsibilities of Chief investment strategist at Manulife Investment Management.

Macan Nia

It's back to school time and thank goodness for that. I think that's the, that's the sentiment shared by any parent on the call today.

Macan Nia

And we've typically taken this back-to-school timing as a great time to update our clients on our outlook for the rest of the year.

Macan Nia

Now, we've gone through a lot of volatility over the past month and a half. But despite the volatility, equity and bond investors have been rewarded in 2024. However, moving forward, questions still remain. From a macroeconomic perspective, the questions that are being asked by investors are what will the slowdowns across the world look like?

Macan Nia

Are some economies more vulnerable than others? From an equity perspective, is now the time to rotate out of tech heavy mega-cap names into small cap names? From a bond perspective, we've had a very strong three month rally in the space. How much runway is left for bonds as we move throughout 2024 and into 2025? And then last but not least.

Macan Nia

Who will drive returns near-term? Is it the winner of the US presidential election, or is it Jerome Powell from the from the US Federal Reserve?

Macan Nia

How do we sort through all the noise in this busy autumn? Are our portfolios positioned properly for both the challenges that lay ahead, but also the investment opportunities? To walk through our market outlook

Macan Nia

What we've decided to do is update are very well received. Happily ever after investment themes. What we've done with our investment teams is we draw parallels through children's fables or nursery rhymes with the current investment landscape today. So Kevin, welcome.

Kevin Headland

Thanks very much. I'm looking forward to it.

Macan Nia

So let's get right into it. So as I said before, the first question we're going to answer when it comes to the macroeconomic environment is the path of growth across the world and whether some economies are more vulnerable than others. So the nursery rhyme fable we've decided to use is Goldilocks and the Three Bears. So Goldilocks and the Three Bears, in a nutshell, is not too hot, not too cold, just right from an investment perspective.

Macan Nia

It's the notion of this soft landing where central banks across the world can lower inflation while having a soft landing. Said differently, not inducing a recession. And we always thought that that narrative, especially throughout the summer, was a little bit more optimistic. We believe that, you know, markets are more likely from a path more likely to continue cooling than to reheat, unexpectedly.

Macan Nia

So let's look across the world in terms of the global economy on this slide that we're looking up here. We're looking at, we are already seeing cracks in economies from an employment perspective. We know what they look like in Canada and in the US. I know in in August we know there is a little bit of volatility, a little bit there. What's volatility after the SAHM rule was triggered. What is the SAHM rule. It's a gauge of employment in the U.S. and what it looks at specifically.

Macan Nia

It looks at the three month average relative to its 12 month low. And that trigger point that colors recessions historically is when it's 0.5% higher. And this is what we're looking at here. SAMH rule has been triggered at every prior recession. Now we got a jobs report. We're recording this obviously on the Tuesday Live. We had the job number last Friday.

Macan Nia

It only added this doesn't capture the job number on Friday. But once you once you update this it only continues to trend that we're moving north of that. Can the SAHM rule be trusted? We can argue in terms of the employment environment post-Covid and whether it applies globally. But you look at other employment measures, they are all highlighting that same thing.

Macan Nia

When I look at it from a Canadian bureau, when we look at it from a Canadian economy perspective, look no further than the Canadian bank earnings in Q2. We've just gone through them. The Canadian banks have set aside $4.4 billion in provisions for potential loan losses. So the banks are seeing potential risks moving forward for the Canadian economy.

Macan Nia

We continue to see them. So in a nutshell, Kev, when we look at the global economy again, that Goldilocks not too hot, not too cold, we would argue. We have been arguing since the summer that we believe that it's much likely that porridge is much more likely to continue to pull than to reheat unexpectedly.

Kevin Headland

Well, the Goldilocks economy is such a well known,

Kevin Headland

term for the economy. You know, just a perfect, not too hot, not too cold, as you said, just right.

Kevin Headland

I think the key is here. We can't argue the direction we can. Maybe argue the timing of a slowdown. Do we get a recession or not? It's not a big recession.

Kevin Headland

Not above the direction we see things slowing. You talked about a few of these indicators. Look at the leading economic indicators by the U.S. Conference Board, the U.S. Conference Board. Leading economic indicators on a year over year basis has been negative every month for over the last two years, typically after being negative for three months, you start to see a risk of recession.

Kevin Headland

We're starting to see those signals already. It's taking a little longer this time around, but I think it's hard to argue that we are in a slowdown environment.

Macan Nia

And just one quick point is the top consumer has been carrying the bottom consumer. So the top third of income earners account for 55% of consumption. The bottom 15 is roughly

Macan Nia

sorry, bottom third is roughly 15%. The higher end has been pulling up the up.

Macan Nia

The lower end we're seeing signs in earnings. Look at Walmart. Walmart pointed out that for the first time in quarter, like many quarters, they're seeing middle to higher income,

Macan Nia

producers start coming to their stores.

Macan Nia

So there's already cracks appearing in that really cohort that has been resilient over the past couple of years now.

Kevin Headland

It's great talking about cracks. Say we're talking about the equity markets. Well, we're starting to see volatility now. We're starting to see equities start to roll over or perhaps not do as well as they expected.

Kevin Headland

For equities. We look at the ugly duckling. You know the ugly duckling is a proverbial lake. Ducks are born and you have one who does doesn't feel like they belong and they think they're the ugly duckling.

Kevin Headland

But eventually they find out there are beautiful swan. In the end, this is kind of way we're seeing equities right now. We've been following these ducks and saying we should be always following the herd and going there, but perhaps we really should be looking for what we think might be the ugly duckling, but turns out to be the beautiful swan in this were active management is so important identifying that company that perhaps is unloved.

Kevin Headland

But really is the winner in the end. As important as I said, we've seen some volatility already. We have great returns year to date and markets for

Kevin Headland

S&P 500, Nasdaq, even TSX and Mid-caps in Europe. They've done fairly well year to date. However, in certain indices a lot of it is this last three months.

Kevin Headland

What's happened most recently is of course, it's all about Nvidia. Nvidia has been driving returns a lot of focus on the Mega-cap names, but really it comes down to that one name that's really driving returns

Kevin Headland

When you go ahead and look at some of the risks to earnings growth going forward, here's where we see the weakness. We've been talking about this for some time. Well again back to the PMI data. The manufacturing data tends to lead earnings growth.

Kevin Headland

And of course is not about earnings valuations. Well we look at valuations. We're seeing this move here where perhaps markets are little more expensive than they have been.

Kevin Headland

But at the same time, we don't believe small caps are necessarily the right answer. We think Mid-caps are perhaps that unloved sweet spot in the middle there. Perhaps they're the ugly duckling in this, in this story where we want to focus on reallocating mid-caps as their earnings profile looks a bit more sustainable, especially in a weaker economic environment than their small cap peers, valuation is not that different.

Kevin Headland

Yes, on an index level perspective, it might look a little bit expensive, but there are a lot of opportunities on an individual perspective we want to take advantage of here. So be careful about making the big rotation from large caps or may cap names just a small caps. We saw some volatility there. Going back to

Kevin Headland

the beginning of June of July.

Kevin Headland

Excuse me, July 6th. Roughly where we have the bottom of the markets through to Friday.

Kevin Headland

The actual, the mid-cap market actually outperformed small caps with less volatility. So despite the notion of a rotation, mid caps were actually the better performers. So we think the right balance here is good for large caps to mid-caps not necessary to jump from large caps to small caps.

Macan Nia

and a couple of points I wanted to point out from the equity,

Macan Nia

we keep saying active management and perform.

Macan Nia

And it's a very cliche, but this most recent earnings, there's many company reports that highlight the importance of that. Let's look at the six Canadian banks as an example year to day returns. And I did this as of Friday of last year last week or last the March of last year. Last week is the difference between the top performer, which is CIBC compared to the worst performer, which is BMO is almost 40%.

Macan Nia

Historically, the difference between the top performer in the bank and the number 61 is in that mid-teen. So that active management is showing its importance even in the Canadian retail bank space. We're not retail bank, but Canadian bank space. That is typically they trade very close to each other. We highlighted U.S. earnings. Look at again going back to the consumer, Ferrari high end trading at a five year high dollar tree trading at a five year low.

Macan Nia

So even in I know you hate this question and I know why we get questions by based on sectors. They're both in consumer discretionary. They have both have very different fundamentals. But it points to when we get asked questions about sector. There's such nuances underneath the hood that it doesn't really,

Macan Nia

matter. And last but not least we were joking about this.

Macan Nia

Look no further than Nvidia's earnings in Q2. We were laughing at the headline news that there is these Nvidia watch parties. So people are gathering at bars, drinking in anticipation of the Nvidia earnings release. And CEB, if that doesn't speak to the euphoria I don't know. Wow. Well, now that's not a cause for concern. But it gives me and you know, times to just pause, take a step back and say, does this make sense?

Macan Nia

Are our portfolios positioned properly in the event that there is volatility because of this concentration risk.

Macan Nia

So let's transition to the next asset class fixed income the three little pigs. Many of us are familiar with this. We have these three little pigs. They're building their houses out of different materials in anticipation of the wolf coming and blowing it over.

Macan Nia

The whole premise of this is the importance of building your house out of the right materials to withstand whatever may come in the future. When we look at the fixed income opportunity today, we have been preaching this for really the past year and a half is the importance of patience and the importance of flexibility. These are bond returns for 2024.

Macan Nia

The Green Line is a year to date returns. The blue is the three month return. So across the board you have seen one difference between last year bonds. I've started the party earlier this year than they did last year. A lot of the bond return this year has been driven over the last three months. Not a surprise. Markets were pricing in central banks, cutting rates.

Macan Nia

Going into the summer. You've seen the performance. As a result, Canada has underperformed its US peers. This is a difference in income or yield to start the year. Nothing to do with credit quality. But you just had a higher income. But you see across the board bonds have participated. They've done well over the last three months. The question we're receiving is, okay, is the bond party done?

Macan Nia

What does it look like as we move forward

Macan Nia

and we think there's still runway left? We had defined the bond opportunity in three phases. Phase one the sweet spot. So a central banks raised rates 2022 onwards. Just click the coupon. The coupon was enough. Eventually we would transition to this phase two. In the phase two essentially is that you know, we start cutting rates.

Macan Nia

You want to add,

Macan Nia

the rate word is selectively to duration. And then last but not least is when we've priced in a recession. That's not phase three. You want to be adding to risk where we are today. And you see where we've highlighted. We believe Canada is in in phase two ahead of international and the U.S., but we are in the early parts of phase

Macan Nia

phase two, we get questions from from clients saying, okay, should I be adding it to long in duration, long end of the curve?

Macan Nia

Should I be adding materially to duration? We would suggest you don't have to. From a risk adjusted perspective, we think in the belly of the curve there's a good opportunity from, again a risk adjusted perspective. And our PMS are finding those opportunities as well.

Macan Nia

So as we move into one area that we would, you know, again, when we talked about tech from the bond perspective, taking a step back, it's from a high yield perspective there.

Macan Nia

Not that there's not opportunities in high yield. But again going you have to be very selective.

Macan Nia

We are looking at the spreads here for high yield and investment grade. High yield is blue. Investment grade is green. This goes back to the 90s. And this is a percentile rank of the spreads. So let's focus on high yield here. So that blue line is saying I'm going to use round numbers that essentially 10% at a time.

Macan Nia

Since the 90s high yield spreads have been tighter.

Macan Nia

Think about the macro backdrop that we have outlined moving forward. If we if you believe us that we believe we're getting towards the end of the economic cycle, does it make sense that spreads are 10%? What has to happen for those spreads to go in even more? We think there's more risk to the upside for this and upside.

Macan Nia

Anything negative when it comes on high yield,

Macan Nia

doesn't mean that there's not opportunities in high yield. But we have to be very, very selective in the fund flows. I've shown that advisors and clients have chased high yield returns. We would caution, you know, there wouldn't be a bad time per rebalance that is there much runway left in bonds.

Macan Nia

So for the income perspective, there's still income to be made. Also from a price total price appreciation perspective, there's opportunities.

Macan Nia

the question we get is, okay, is it likely that the bond can keep going?

Macan Nia

Well, it depends on what you think, what central banks will do. So right now a third there's roughly 80 central banks we follow. Roughly a third of them are cutting rates. And when we look at it from a GDP perspective, it's actually 50%,

Macan Nia

the GDP, global GDP run by central banks aren't cut more early stages of cut mode.

Macan Nia

So we believe that continues. We believe there's still runway left for the remainder of 2024 and 2025 for the bond thesis to unfold.

Kevin Headland

You talk about central banks. And of course, the Federal Reserve has their,

Kevin Headland

announcement next week, fully expecting a 25 basis point rate cut. We aren't on the side of a 50 basis point cut.

Kevin Headland

The market's expecting probably roughly four cuts over the next three meetings, so there might be a 50 basis point cut somewhere there. We're still in the, the belief that we're going to get 3.5 basis point cuts and see cutting in I think that's the key is not about what's coming by the end of this year, it's direction.

Kevin Headland

We are finally on the beginning of the rate cut cycle in the US, of course, the largest economy we're already seeing in Canada, they're laying to continue cutting rates. The key is those risks. The balance of risks is too low rates, which tends to be good for the bond market. And this chart is a great example where you look at the price to say there's a lot of runway here for price, not so much on the high yield, but more so on the other higher quality,

Kevin Headland

type of products.

Kevin Headland

And fixed income is where we you talk about flexibility, but also patience. We have to have both fixed income returns don't come overnight. They're not like equities. It's not like tomorrow. All of a sudden we up 10%. But the runway is still very attractive. And we think from that perspective a balanced approach really works well. Fixed income. We have a lot of product available.

Kevin Headland

We just launched two new liquid all products

Kevin Headland

for Manulife. Those are great opportunities to invest in fixed income because they have more flexibility. That is key using liquid alt strategies or opportunities to add flexibility to make sure or trying to achieve the results,

Kevin Headland

that our investors want. So that's really attractive right now.

Macan Nia

And that's the that's the key point. We'll get questions on bonds. Well ultimate depends on what you're looking at for bonds within your asset allocation. What's the purpose of them. So you talked about the liquid the liquid ultra

Macan Nia

liquid assets. But also from the ETF landscape. We have a basket ETF that has been extremely well received extremely flexible king all across the credit structure.

Macan Nia

So if you're looking for that flexible mandate it depends on what you're looking for. Bonds.

Macan Nia

We have many solutions I mean life investment management I could fit it into one point I want to stop on with bonds before we move on that dynamic between bonds and equities. The purpose of them was broken during Covid, right? They both moved together well in the wrong in a wrong way.

Macan Nia

And you know what clients question okay. Moving forward. Is that the new norm. Well look at the past three months to show that that norm is gone. The new norm is the old norm where you know what bonds move inversely to equities. They hold an important part within your asset allocation, not only from an income perspective, but also from really a total return when equities are selling off now your bonds are acting as their counterweight.

Macan Nia

And we think that continues moving forward.

Kevin Headland

We talked about bonds you know supporting equities. It's a perfect segue to volatility. We have experienced market volatility for the first time in quite some time just over the last couple months. And I think that's something people aren't used to. They're waiting for you feel all safe and secure until you're not, is why we use Hansel and Gretel as a great,

Kevin Headland

fairy tale for market volatility.

Kevin Headland

Of course. Hansel and Gretel,

Kevin Headland

unfortunate left in the woods. But they come across a very nice woman who takes them into their house, and they feel all safe until that nice woman ends up being a mean old witch that wants to eat them. Now, we've talked about this before on,

Kevin Headland

fairy tales aren't always very, you know, nice and positive.

Kevin Headland

They actually can be very dark.

Kevin Headland

Unfortunately for us, maybe not right for for children after all.

Kevin Headland

But what happened here is Gretel took advantage of an opportunity to escape by pushing the witch into the oven. So this is where during volatility, when things are fearful, instead of being paralyzed by that fear, Gretel wasn't paralyzed. She actually took advantage of that.

Kevin Headland

And investors should be taking advantage of volatility when it happens. So understanding what happens when we get volatility is we get a spike in the VIX. The VIX is the

Kevin Headland

index that measures volatility or implied volatility on the Sp500. Typically we don't see spikes in the VIX. It kind of fluctuates roughly on average long term it's around 18.

Kevin Headland

But it's spiked in the summer or about a month or so ago over 30 almost 40 at the day's end. However 30 is a key indicator. We want to look at that 30 as an opportunity to invest, because what happened is not so long after the VIX dropped lower. And what happens is markets rallied. We expect to see more choppiness in equity market more volatility.

Kevin Headland

Perhaps you don't get the spikes like we saw before. But it won't be surprising to see more volatility. Why a lot of headline risk. We of course have

Kevin Headland

the Federal Reserve. And whether they're going to cut 2550 maybe don't cut at all. Still a lot of uncertainty there. Perhaps it's

Kevin Headland

earnings

Kevin Headland

expectation that change perhaps is economic data that comes in weaker than expected markets where price for perfection

Kevin Headland

not too long ago and any uncertainty really drove those returns lower on the short term.

Kevin Headland

And of course, the big perhaps headline that could cause a little bit of ripple in the equity markets is the US election coming. A lot of talk about that. We get questions all the time about the US election. What Mark, what

Kevin Headland

president does the market favor is a Democratic. Is it Republican? We've done some calculations going back to 1945.

Kevin Headland

And essentially this sign every calendar year, return to the sitting president at the time and here you have the averages going back to 1945, in all years, roughly 12

Kevin Headland

8% for the Sp500 in a Democratic president year, you have just over 14%. And in a Republican present year, just under 11. Now, this chart would allude to the fact that the market actually prefers a Democratic president.

Kevin Headland

However, the problems averages is sometimes gets skewed by really bad years. And unfortunately, a Republican president has been in power during some recently weak years, such as 2008. So let's not just take this,

Kevin Headland

chart and say it's going to favor Democratic president. Ultimately, it doesn't really matter. It's about the economy, about the earnings less so about who is sitting in the white House.

Kevin Headland

And of course, when we see the VIX surpass 30, we've done some calculations. Well, going back to the 1990s, every time the VIX has surpassed 30 the level we've talked the four returns.

Kevin Headland

And Warren Buffett had a great quote. You know, you want to be

Kevin Headland

greedy when others are fearful and fearful. When I was the greedy I think that's the case. You want to be active when you see volatility. So we do get it going forward. Do not go to cash not run for the hills. We want to stay invested and make sure we're on a pathway to success.

Kevin Headland

Yeah.

Macan Nia

And when I look at this I just think of investing is two things to me anyways. It's the ability to control your emotions and it's also the ability to gauge probabilities. The challenge is, is when the probabilities are in your favor, your emotions are running high right. So when the VIX is over 30 probability stating you should invest.

Macan Nia

But your emotions are running high because you've seen a sell off. But again going back to the numbers on any given day like let's say tomorrow Wednesday we wake up. The odds of the market be positive or negative is a coin flip. Basically, our kids have an equal the chance of predicting day to day moves as we do.

Macan Nia

But when you look at your time horizons, even a one year rolling time horizon over the last 50 years, markets have been up 80% at a time over just one year. Now, if we extend that time horizon, which is the time horizon of many of our clients, even five years, that basically goes up to 90%. So yes, that it provides opportunity to buy the volatility.

Macan Nia

But I think it's important to take a step back, try to remove the emotions, look at the numbers and the numbers suggest we get these sell off. Look just close your eyes and you buy.

Kevin Headland

We get it comes back to be a rocket on as well. We all know that investors feel losses two times harder than wins or gains. And when you see those losses in your paper, when you see that those headlines and you follow media, it can be very daunting. But it's hard to do and make sure we stick to a plan.

Kevin Headland

And, you know, essentially that is what Financial Advisors goals is,

Kevin Headland

therefore is to hold those investors hands, make sure they,

Kevin Headland

you know, carry through that out there and keep their their money invested for their goals.

Kevin Headland

Now, we talked about, of course,

Kevin Headland

some great, investments,

Kevin Headland

during this chat in the webinar today.

Kevin Headland

One key thing is we're not just about the funds that Manulife has are we talked about today, but we have a wide breadth of investment

Kevin Headland

opportunities and offerings, for investors and their clients.

Kevin Headland

now of course, Morgan, for those who want to follow us,

Kevin Headland

there lots of ways to follow us. We have our very popular Investors Unplugged podcast. You're probably listening to us potentially on a replay on our podcast. We have our monthly email. It's often only. So you have to reach out to us or your wholesaler to join that list.

Kevin Headland

We're getting up to over 2500 visors. They get this,

Kevin Headland

email on a monthly basis in both English and French. So we have both languages available. Of course, we have viewpoints. And that's the notes on our website. Very popular chart book. We're almost I think we're over 100 charts now,

Kevin Headland

on that chart book. So lots of information there.

Kevin Headland

I'm always looking to add. So if you have ideas please do so. And then finally, LinkedIn, we're posting on LinkedIn, at least on a weekly basis, we think is a great way to provide information to you and your clients if you're not already,

Kevin Headland

linked to us, please reach out. And by all means, like our material reshare, repost this.

Kevin Headland

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Kevin Headland

Once again, I want to thank you very much for joining our webinar today. Please look out for invitations for our next,

Kevin Headland

Manulife Market Insights monthly, and we'll welcome you on our next call. Thanks so much.

Macan Nia

Thank you.

Kevin Headland

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Kevin Headland

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Kevin Headland

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Kevin Headland

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