Daily roundup of research and analysis from The Globe and Mail’s market strategist Scott Barlow
Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, says the U.S. economy is in a “show me” phase,
“While US equities have retraced most of their midsummer swoon, assets such as US Treasuries, industrial commodities and gold suggest more skepticism. Meanwhile, nearly all segments of the Treasury yield curve have “uninverted,” marking the “show me” phase of the cycle. With disinflation seemingly secure, the bulk of anxiety is now directed at the labor market. Gradual cooling there would be consistent with a slow-moving Fed, meaning that recovery in rate-sensitive areas could prove frustrating amid higher-for-longer rates. Alternatively, a rapid cooling of job prospects could risk recession and a Fed policy mistake. For equity investors exclusively exposed to the passive market-cap[1]weighted index, risk may be mismatched with the nuances of the forward trajectory. When it comes to “sticking the landing,” we are entering the danger zone: Stay at maximum diversification. Consider owning the equal-weighted S&P 500 Index”
“The GIC Weekly: How Far, How Fast” – Morgan Stanley
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Piper Sandler strategist Nancy Lazar is expecting a U.S. recession in It’s Different This Time. Nope ,
“What is cyclical employment? It’s payrolls minus government, health care, and education … totaling 78% of all employment. And last month it fell -58k – now down a cumulative -271k since its May 2023 peak (blue dots below), and is declining at a quickening pace. Why does this matter? Well, going into the last 3 “real” recessions (1990, 2001, 2008), cyclical employment ALWAYS turned down before headline payrolls … Net, only health care services, govt, and construction are boosting payroll employment – and that lack of breadth is NOT a healthy labor market signal … Between the higher funds rate and tighter bank lending standards, broad revenues risk declining significantly … , cyclical jobs are down because broad revenues are faltering on the long-lagged impacts of Fed tightening … 1) Aggressive Fed tightening is slowing corporate revenues, in turn, 2) Pressuring cyclical employment, and 3) Increasing the unemployment rate. Looking back, whenever there’s been such a tough Fed tightening cycle (funds +525bp), there’s ALWAYS been a recession – not to mention this cycle’s 20% Fed balance sheet contraction”
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Goldman Sachs strategist Christian Mueller-Glissmann is not concerned about a bear market yet,
“Strong price momentum as well as negative inflation levels and momentum (allowing for central bank easing) point to lower drawdown risk, while recent negative growth momentum and elevated Shiller P/Es point to elevated risk. The negative growth momentum suggests a larger probability of a >10% correction - recent higher equity volatility also points in this direction. n Combining all variables indicates that drawdown risk has picked up but remains relatively low at around 20% - historically, levels above 30% indicate a clear warning signal. In addition, valuations are a key driver of elevated drawdown risk - ignoring the absolute Shiller P/Es level points to lower risk. n With elevated equity valuations, mixed macro momentum and rising policy uncertainty, there is the risk of more equity drawdowns, in our view. As a result, we believe risk-adjusted returns for equities are likely to be lower into year-end. However, we think the risk of a bear market remains low with relatively low recession risk, helped by a healthy private sector and central bank easing”
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RBC Capital Markets bank analyst Darko Mihelic published a mammoth 210 page update on the domestic banks. This is from the summary,
“In Q3/24, the median core EPS for the large Canadian banks we cover increased ~3% QoQ and ~5% YoY. Our core EPS estimates and price targets increased slightly except for BMO where we reduced our estimates and price target to reflect higher provisions for credit losses (PCLs). On average, we expect core EPS growth of ~8% in 2025 and ~10% in 2026. • The average total PCL ratio decreased 2 bps QoQ to 40 bps while the average impaired PCL ratio was stable QoQ at 36 bps in Q3/24. Total PCLs increased ~7% QoQ and ~25% YoY, primarily reflecting BMO’s increase of ~29% QoQ and ~84% YoY, the highest QoQ and YoY increases in the group. Impaired PCLs increased ~6% QoQ to $3.2 billion, mainly reflecting BMO’s ~26% QoQ increase to $828 million. Average core net interest margins (NIMs, excluding trading NII) for the large Canadian banks we cover expanded 3 bps QoQ and 6 bps YoY … As of August 30, the Canadian bank index traded at 11.1x on a forward P/E basis, above its long-term historical average and its 10-year average of 10.8x . On a P/B basis, the Canadian bank index traded at 1.48x, below the 10-year average of 1.65x. Year to date, the Canadian bank index’s total return was 11.2%, versus the U.S. bank index’s total return of 26.8% YTD. We believe there will be more upside to valuations following peak PCLs and signs of improving economic growth and unemployment. It may be that investors gradually come to believe that PCLs will not spike but rather level off (as we model them) in an economic soft landing. Such a leveling off of PCLs would be unusual versus prior credit cycles”
Mr. Mihelic has an “outperform” rating on only one major bank – Toronto-Dominion Bank. He does not cover Royal Bank.
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Diversion: “Colombian Court Orders Culling of Pablo Escobar’s Hippos” – Gizmodo