The global landscape is at a pivotal moment with several key geopolitical and financial events intersecting. This situation presents both opportunities and risks for investors.
Key Points:
- Geopolitical Shifts: The war in Ukraine may be nearing a resolution, as the EU remains the main supporter of Ukraine and the US is replacing Russia as the EU’s primary trading partner. However, tensions in Lebanon are escalating, potentially leading to a broader conflict in that region. Already experiencing explosive growth, India will likely continue to gain economic power as the West seeks to reorient its supply chains away from China.
- Economic Dynamics: The Bank of Japan is shifting from a dovish stance to raising rates, contrasting with the US Federal Reserve and other central banks. This could lead to significant liquidity movements.
- Market Sentiment: US tech stocks are reminiscent of the year 2000, with concerns over AI overcapacity outpacing viable business models and leading to a tipping point in tech fields.
- Precious Metals: In times of instability and economic stress, such as a mounting debt crisis, precious metal stocks tend to perform well, especially alongside a rapidly increasing housing inventory and unemployment on the rise.
- Canadian Fiscal Situation: Record government debt levels and continued high deficits coupled with lowering interest rates will likely impede future bond sales. Capital access difficulties will also persist in the startup and small cap space.
Commodities
China’s surge in copper exports has led to a significant drop in prices. This trend raises concerns about whether “Dr. Copper,” often seen as a leading indicator of economic health, is signaling an impending economic slowdown. While the role of energy transition provides the “bull” case for continuing copper deficits, waning demand for EV’s coupled with decreasing government subsidies makes an investor question the long-term support for copper.
Rising Unemployment and Economic Concerns
Unemployment is rapidly rising, potentially triggering the Sahm rule, which can indicate the onset of a recession. Increasing unemployment could also signal broader economic issues, making a recession more likely in the US and possibly affecting global markets.
Government Debt & Economic Impact
Both US and Canadian government debt levels are at record highs, and growing much faster than the underlying economy. In July, US federal debt exceeded $35 trillion, with the Congressional Budget Office projecting that interest payments will reach $870 billion in fiscal 2024. By 2025, these payments are expected to consume 20.3% of federal revenues. This debt burden puts additional strain on economic growth, limiting the government’s ability to respond to economic challenges.
Consumer Financial Strain
Consumers appear to be facing financial challenges, as illustrated by rising credit card delinquencies. This strain is further highlighted by the lacklustre performance of retail stocks as the S&P Retail Index is only up 2% year-to-date compared to an 18% gain in the broader S&P 500 index.
Gold’s Bullish Trend
Gold has recently broken out, signaling the start of what appears to be a sustained bullish trend, despite the potential for short-term corrections. This situation is reminiscent of the 1973-74 stagflation crisis and the tech bust, which mirrors the current economic environment. The performance of the gold to S&P 500 ratio performed significantly better during these periods, especially following yield curve inversions, suggesting a favorable outlook for gold in the present context. Select gold equities will also provide critical portfolio diversification and a hedge against overall market volatility.
Equity Markets
Despite strong economic performance, declining inflation, and expectations of further rate cuts having driven markets to historical highs, earnings growth has lagged. The S&P 500’s P/E ratio currently stands at 27.1, significantly above the long-term average of 17.6. This disparity suggests potential market overvaluation and indicates a possible vulnerability to future corrections.
The BOJ created turmoil last week with a 25bps hike in rates sending funds over levered in the carry trade to quickly reduce positions. Notable pullbacks were seen in large cap tech and bitcoin highlighting the crowded nature of these outperforming trades.
S&P 500 P/E Ratio Trend
Retail is an area of particular concern as consumer spending accounts for 68% of US GDP. June saw minimal changes compared to May, with only a 2.3% increase over June 2023. Retail stocks have notably underperformed relative to the broader market. Companies like Nordstrom and Macy’s are responding by closing stores and investing in renovations to enhance the shopping experience in their remaining locations, adapt to shifting consumer preferences, and improve financial performance.
The Mega 7 stocks (Microsoft, Apple, Amazon, Alphabet, Meta, Nvidia, and Tesla) have seen substantial price increases. This raises concerns about a potential market correction, particularly if the Federal Reserve implements anticipated rate cuts later this year. The situation is reminiscent of the NASDAQ crash of 2000, suggesting these stocks could be vulnerable to a similar “blow-off top” scenario.
Real Estate
Even as central banks adopt more dovish stances, underlying structural inflation pressures remain, increasing the risk of higher CPI inflation and potential future rate hikes, especially in Canada. This makes real estate there particularly vulnerable, and a retreat to 1990 levels is possible as sales decline and inventory rises. Reflecting the perceived risks in mortgage portfolios, the Toronto-Dominion Bank has become the most shorted bank globally since 2023, indicating investor concerns about the stability of the housing market and banking sector.
Technology
As previously noted, the Mega 7 stocks have seen substantial gains but are extremely vulnerable to downside shocks if their heavy investments in AI don’t yield expected revenue results. For instance, Microsoft dropped 7% in share value after their recent earnings announcement, while Meta and Amazon each lost 3% in the same market downturn. This highlights the sensitivity of these stocks to market expectations and the performance of their AI-related ventures leads to speculation that the aggressive infrastructure buildout is ahead of the businesses in the short term. Longer term, however, indications are that AI adoption speed is already outpacing previous tech waves and will significantly impact operating models.
Small-cap tech stocks however have yet to participate in the AI-driven runup and a sector rotation appears to be beginning as the focus shifts to these smaller companies. Nonetheless, the emphasis should remain on earnings quality, especially given the potential for overall market weakness.
Conclusion
Today’s market bears some similarities to both the 2000 tech bubble and the 2008 Global Financial Crisis (GFC), but also differs in key ways. Like the 2000 bubble, we’re seeing high tech valuations driven by easy money and speculative behavior. However, many of today’s tech giants have solid business models and strong cash flows, unlike the early 2000s. The 2008 GFC comparison comes from concerns about financial stability, with rising interest rates and tighter liquidity exposing market vulnerabilities. While inflation, geopolitical tensions, and shifting monetary policies add pressure, these structural changes may mitigate the impact of a potential downturn. Still, the market’s blend of old and new risks makes cautious navigation essential.
The Bank of Japan’s (BOJ) recent rate hike marks a significant shift from its traditionally loose monetary policy, with broad implications for global markets, particularly in crowded trades. Investors who have heavily bet on low rates and a weak yen now face the risk of these positions unwinding, potentially leading to increased market volatility as portfolios are adjusted. The BOJ’s move could trigger broader sell-offs or sharp reversals in asset prices, affecting global currency markets, bond yields, and equity valuations, especially in areas reliant on Japanese capital.
In response to the current global scenario, our strategy emphasizes assets with strong cash flows and robust balance sheets, capable of withstanding inflation and rising interest rates. We see particular potential in smaller-cap assets and remain bullish on gold, a historical safe haven. Our portfolio also includes infrastructure investments for stability and growth. With growing concerns about tech stock volatility, weaknesses in real estate and retail, rising unemployment, and increasing debt, a diversified approach is key to resilience and profitability. The combination of tighter monetary conditions, supply chain disruptions, and regulatory pressures challenges tech companies, while gold miners stand to benefit from rising gold prices. This shift in investor sentiment towards safer, more tangible assets could lead to gold and miners outperforming tech in the near term.
About Moneta
Moneta is a boutique investment banking advisory firm that specializes in advising growth stage companies through transformational changes including major transactions such as mergers and acquisitions, private placements, public offerings, obtaining debt, structure optimization, and other capital markets and divestiture / liquidity events. Additionally, and on a selective basis, we support pre-cash-flow companies to fulfill their project finance needs.
Moneta is proud to be a female-founded and led investment banking advisory firm. Our partners bring decades of experience across a wide variety of sectors which enables us to deliver exceptional results for our clients in realizing their capital markets and strategic goals. Our partners are supported by a team of some of Canada’s most qualified associates, analysts, and admin personnel.