Downbeat consumers still expect the stock market to go higher.  Households may feel worse about the economy, inflation, and personal finances, yet expectations for higher stock prices over the next year actually rose to 57.9% from 57.0%. That split captures the strange psychology of this cycle: economic pessimism is not weakening the equity-market bid and may even be reinforcing the belief that stocks are the only available shelter for purchasing power.  Consumer spending has also remained buoyant even as job growth slows because individuals have been running down their savings rate to fund this spending.  That is the ‘wealth effect’ in full force.  Sentiment data supports these views as consumer sentiment plunges to an all-time (75-year) low while investor expectations of higher stock prices over the next year remain near record highs, despite the war and the surge in oil prices.  In the chart below, the left panel shows consumer sentiment as measured by the University of Michigan Survey.  The most recent report pushed it to an all-time low.  The right panel, on the other hand, show Conference Board expectations of a stock price increase in one year (percent of respondents who said ‘higher’).  The dichotomy is striking and, in our view, probably reflects the fact that the increase food and gasoline prices are a huge negative for the middle- and lower-class income levels which are reflected in the U of Michigan consumer surveys.  The wealthy portion of the population, which are the ones that tend to have stock portfolios that have been inflated by this bull market make up the bulk of the Conference Board data.  Just more evidence of the ‘k-shaped’ economy.

That stock market optimism is also being reflected in the holdings of stocks by investors in the U.S. and elsewhere.  Data released this past week show Bank of America’s private clients, with $4.5 trillion in assets, hold a record 65.7% of those assets in equities.  Meanwhile, their cash allocations, at 9.8%, are the lowest on record.  Investors are clearly ‘All in’ on the stock market!   

Leading Indicators Point to Significant Slowdown: The Conference Board’s composite index of leading economic indicators (shown below) hit a 12-year low in March, as uncertainty from the Iran conflict started to bite. The index dropped to 97.3, its lowest level since November 2014, with the largest decline since Liberation Day a year ago.  The one-month diffusion index also slipped from 70 to 50, a five-month low. The main drags came from declines in the manufacturing workweek, ISM new orders, building permits, the S&P 500, and consumer expectations. Building permits were the biggest negative contributor, posting their largest drag since the depths of the pandemic in April 2020.  Certainly this is a different economic signal than we are getting from the bullish outlook from the technology and associated industries.  Meanwhile, as we head into the key summer driving season, consumers in the U.S. are facing gasoline prices over US$4.50 per gallon while in Canada we are seeing prices per litre closer to $2 than $1.    

Good was not ‘good enough’ for Canadian banks.  Canada’s biggest banks reported their second-quarter earnings this week, covering the three months that ended April 30.  All six banks reported higher profit that beat analysts’ estimates and all except CIBC also raised their quarterly dividends. The source of earnings strength came from the usual recent sources; strength in capital markets and wealth management emanating from the ongoing bull market in financial markets as well as cost cutting that improved the efficiency ratios across the board.  Most of the banks took loan loss provisions that were a bit less than expected, providing another boost to earnings.  On the other side of the ledger, loan growth continued to be basically non-existent.  Canadian bank stocks have surged 16% this year on the optimism surrounding the sector’s ability to withstand economic uncertainty, outperforming the S&P/TSX Composite Index’s 8% climb.  But that streak ran into some headwinds this week as almost all of the stocks declined following those stellar earnings reports.  The issue really seems to be valuations!  Bank stocks are not trading more than 40% above their long-term average levels at almost 15 times this year’s expected earnings.  While dividends were also raised by most banks, the strength in the stocks has pushed the dividend yields lower, taking away another core reason why investors have always flocked to bank shares.  On top of that, the economic releases by Statistics Canada today showed negative economic growth in the first quarter which put the Canadian economy in a technical recession (defined as two consecutive quarters of negative growth) at the same time as Canada is facing a tough set of negotiations on the renewal of the USMCA.  The road ahead for the banks is looking a little less rosy.  We have an underweight in Canadian financials in client portfolios.  Our only holding is RBC, which has always traded at a premium to the group due to its great strength in domestic banking.  But the rally in the rest of the sector has narrowed that premium such that RBC is looking like the best relative play in the sector right now.

The opportunity in gold stocks.  After a parabolic two-year run, gold has lost momentum. The first leg of the correction came as leveraged speculative positions unwound after bullion pushed above $5,400 per ounce by the end of January. The second came with the Iran war, which drove oil prices sharply higher, revived U.S. dollar strength, and pushed bond yields up. Precious and industrial metals were already vulnerable after steep gains, and the war shock added a powerful macro headwind with higher oil, higher rates, and a stronger dollar.  The selloff has led some to argue that gold has lost its “safe haven” status. We don’t believe that is the case.  In a geopolitical shock that raises oil prices and pressures the currencies of oil-importing countries, gold can become a source of liquidity. Countries facing current-account pressure, inflation risk, and short-term dollar needs may sell gold reserves to defend their currencies. That does not undermine gold’s reserve-asset role as central banks are expected to continue to diversify away from fiat currencies, particularly the U.S. dollar, to real assets such as gold.  Gold is now hovering in the $4,400–$4,600 per ounce range, roughly -15% below its highs.  Gold needs some easing in the U.S. dollar and in the yield curve conditions to regain traction.  That is where the miners become interesting. Canadian gold miners typically trade with roughly 1.7x beta to the gold price, making them a leveraged play on the bullion. The equity market has marked them down alongside spot gold recently, but it may be underestimating the earnings power of the companies still embedded in today’s gold price. Even after the pullback, bullion remains above $4,000 per ounce, more than double where it stood two years ago. That should continue to support strong revenues, free cash flow, and profit growth.  We favour North American producers in order to limit geo-political risks.  Our core holdings in the sector remain Agnico-Eagle, Barrick Mining and Torex Gold. 

We have not made any substantial changes to investment portfolios in the past month, outside of the noted slight increase in our gold stock holdings and a reduction in the financial sector.  We have reduced stock allocations slightly, down to the 45-48% range from 50-55% and raising some cash in the process.  While we have not added to our bond holdings, we are getting more intrigued by U.S. long-term bonds, with a yield of over 5% now, versus similar Canada long-term bonds which yield about 3.8%.  While Canada does face more economic risks in the shorter term, particularly from the risk of increase tariffs is a renegotiated USMCA does not happen on a timely basis, we don’t see as much opportunity for long-term yields to drop much further while core inflation is still running close to 3% and oil prices remain high.  We added slightly to our holdings in oil stocks as we believe that the conflict in the Gulf will keep prices ‘higher for longer’ than most investors expect. Gold’s pullback looks more like a short-term macro unwinding as the structural story remains intact. Higher oil prices, a firmer U.S. dollar, and rising bond yields have pressured bullion, but central bank demand, fiscal risk, and geopolitical fragmentation remain intact.  We also continue to like the industrial and engineering companies that will be beneficiaries of the increased fiscal spending in Canada.  In technology, although we slightly reduced our overall exposure on the recent sharp rally, we like the risk-reward trade-off for software stocks which continue to be hurt by worries about an incursion into their core applications from the growth of AI.  We believe that the low valuations account for much of these risks, with all our names still showing double-digit revenue and earnings growth as well as being significant free cash flow generators, which supports stock buybacks. Core portfolio holdings include Shopify, Constellation Software, Lightspeed, Uber, SalesForce and Workday along with hyperscalers Alphabet, Meta, Amazon and Microsoft.   

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