Sadiq Adatia, chief investment officer at BMO Global Asset ManagementSupplied
U.S. equity indices have delivered impressive gains in 2024. Year-to-date, the S&P 500 Index as well as the NASDAQ Composite have outperformed the S&P/TSX Composite Index by a wide margin.
A resilient U.S. economy and better-than-expected earnings announcements have helped fuel the U.S. stock market rally. According to a research report released by LSEG on October 23, of the 96 companies in the S&P 500 that have reported their quarterly earnings results, 81 per cent have beat expectations.
To get an overall picture on the U.S. markets, The Globe and Mail recently spoke with Sadiq Adatia, chief investment officer at BMO Global Asset Management, for a two-part interview. In part two of this interview, he shares his views on potential opportunities and risks he sees in U.S. stock markets.
Earlier this week, part one was published, which featured Mr. Adatia’s outlook for the S&P/TSX Composite Index as well as his expectations for the Canadian dollar.
You believe U.S. stock market outperformance will continue. Why don’t the record levels for major U.S. indices and the high valuations concern you?
When we look at the underlying economy and we look at what are risks to the underlying economy, we don’t see a lot actually. The consumer is resilient, they continue to spend. When you look at the U.S. economy and you look at the areas that are driving the new all-time highs, these are things that are tied to AI cloud computing, automation, these are long term trends with mega cap companies that have invested billions of dollars into it. And the market is valuing them on this future growth. So, we see that continuing. Growth could slow down on the performance side, but I still think these are the areas that are going to continue to drive the markets higher from here.
The second part to that is that we see rotation. So, if we expect the tech companies that have done really well to maybe not grow as much on a stock price perspective, other aspects of the market are now starting to get some momentum. And wider breadth across the markets can lead us to significantly more higher highs.
And the interest rate cuts from the Fed are going to also help because that means valuations can go higher even if earnings stay level. And consumer confidence will increase as well as a result of that. Consumers can continue to spend and support this economy. So that’s why we still think we can go higher from here.
I think it’s important to note, 75 per cent of the time when we have an election in the U.S., markets are higher in an election year. It doesn’t matter if it’s the Republicans or Democrats that win, the markets tend to be higher because everybody’s talking about how they can grow their economy and add to the wealth of the consumer and therefore markets get excited by that.
When we’re in 2025, how do markets fare the year after the election?
So, it does depend. But you still see momentum coming through. The key is the delivering on some of those promises.
What does change is what sectors or geographies win because that does depend on who wins the election.
How expensive stocks get also dictates how 2025 will play out. But as long as the earnings story remains relatively okay, valuations are actually not as high as people think they are. And, if you keep getting rate cuts, then you can have the multiples expand on their own even if the earnings don’t go higher from here.
Let’s discuss U.S. valuations, where they could expand to?
It depends on the extent of further rate cuts.
We expect an additional 50 basis points of rate cuts for the remainder of this year and then to continue next year. But I don’t think it’s necessarily going to be every single meeting that they’re going to continue to decrease. I think that’s more likely to occur in Canada than it is in the U.S.
If we get 50 basis points of rate cuts this year and at least another 50 basis points of cuts next year, even if earnings stayed relatively steady, to me that leads to at least a five to seven per cent additional market return for the S&P 500 in 2025. But it won’t be the same things that drove us this year that will drive us next year.
So, what’s going to drive us next year?
I think more of the value-oriented types of sectors versus the growth sectors.
Are we at or approaching a near-term top for technology stocks?
We feel that technology is still going to be a leader and many of the key technology companies are still going to go higher from here because demand is still there, their strength in the space is still there, but we do think that we’ll start to see other areas of the market, other sectors, play a little bit more of a catch up. So that means that we’ll see a bit of rotation, some profit taking at times and people start to invest money in the areas that haven’t participated as well. Areas like financials, for instance, that have now started to have a bit of a run coming through.
That doesn’t mean we think technology is going to be negative in terms of returns. We just don’t think it will grow as fast from a performance standpoint compared to some of the other areas over the next six to 12 months because expectations are so high, it’s hard to overdeliver on those expectations. Whereas in other areas of the market, expectations are very low so it’s easier to beat and impress the market. That’s why the hurdle is so hard in technology, which is why I think you’re going to have sometimes great numbers that just don’t live up to the expectations, which could cause the stocks to potentially not do as well as they would have otherwise.
How will the outcome of the U.S. election impact your asset mix, sector and portfolio recommendations?
So, it doesn’t change our equity, bond weight story. But it does change where we want to invest.
When we think about regions across the world, China is still going to be a bit of a headwind no matter if it’s Trump or Harris. We do know that Trump will add more tariffs than probably Harris will so that would be a little bit more negative on China. The benefactor of that will be a country like India, for instance, that will win off whatever China loses and really it is not in anybody’s crossfire right now. So, you want to tilt your emerging market exposure a bit more towards areas like India. Internationally, it is more country specific, but again, you have to look at what impacts China. I think when it comes to international markets, it’s going to really depend on what scenarios get played out because what you hear from some of the politicians may not exactly be what they can actually do in reality. So geographically, I think you have to kind of wait and see a little bit.
On the sector side, we like financials. That’s probably one area that you want to be more invested in if Trump wins because he’s even less about regulation, which allows financial flexibility a bit more, which favours some of the financials. Similarly, technology is an area I think that you want to own more with Trump because under the Harris regime, I think there’s a bit more pressure on breakups and not getting too big. But I think technology benefits off some of those strengths going forward. On the other hand, when you think about clean energy, I think you want to favour under a Harris regime. That being said, we know that Musk has now joined the Trump party, and he’s tied to the EV side. So, some of that might be a bit mixed depending on what Trump ends up doing to help support Musk if he actually wins the election. We do like health care. I think there’s undervalued areas of that market that you want to own and valuations are a lot more attractive than you see in technology and other areas.
What concerns you - something that might not be widely talked about?
The concern to me is that interest rate expectations, though they have come in a little bit, I think people are still a little bit overly bullish on rate cuts in the U.S. I think they’re forgetting that the Fed has waited so long because they still feel the U.S. economy is okay and inflation is still a little bit sticky. The economy continues to hold up well, so there’s no need for them to be aggressive. I think they may disappoint consumers when it comes to rate expectations so that could cause a little bit of a jolt in markets.
The second thing is we’re all aware of the geopolitical risks, but I don’t think it’s fully priced in the markets.
And I don’t think this is a risk, but I think if it happens, it would be a big risk if the consumer deteriorates faster than expected. We’re not expecting the consumer to deteriorate overnight that much, it will gradually decline because of higher rates and debt levels. But if they decline faster than expected that is not priced in by markets. If that were to occur, I think that would cause markets drop 10 per cent. But it’s not a high probability for us. It’s a risk that we want to be watching carefully.