While we are still three weeks away from the official start of summer, it’s beginning to feel like it all the same and investors are wondering if the summer doldrums will set in, or are things about to get exciting? This past week saw a little bit of noise re-enter the market from the usual sources. Concerns about inflationary pressures keeping central banks from easing policy, some noteworthy earnings misses and even worries that the AI steam engine might be sputtering. At the end of the day, this is exactly that – noise. In discussions with clients, we have indicated that there aren’t a lot of foreseeable fundamental risks to equities this summer. Economic growth momentum might be fading, but recent indicators are not pointing to a negative shock in the coming months. The real focus should be on what happens beyond the summer.

 

There has been a lot of talk of higher commodity prices because of severe weather and how this could upset the inflation apple cart. Wheat prices have been soaring due to drought conditions, and lower water levels in areas like the Suez Canal and the Rhine could impact shipping. Higher electrical power demand is also expected to send natural gas prices higher. The chart below shows the FTSE/CoreCommodity total return index and in April and May, it has come close to re-testing the recent high set back in June 2022.

 

Source: Factset Research Systems

Yet, there are some key differences between the summer of 2022 and today, especially with respect to labour market conditions and other sources of consumer pain. This includes the burden of higher interest rates and even things like elevated insurance premiums. Against this backdrop, higher costs for food and energy are more likely dampen consumer demand for non-discretionary goods and services. In other words, headline price indexes could see a lift from commodities, but underlying inflation measures are probably going to moderate in response to weaker demand.

 

In terms of corporate earnings, the next batch won’t be here until we get well into July and a full assessment of the second quarter won’t be known until we are in August. This past season had its fair share of misses, like we saw this week with the tech segment and even in the Canadian banking space, but again nothing that pointed to something materially wrong in the quarter. In fact, the first quarter showed overall earnings growth for the S&P500 of 6%, which was the highest seen since the start of 2022.

 

Source: Factset Research Systems

The summer of 2022 was also the beginning phase of rate hike anxiety, underscoring the negative tone that permeated the market all year. That anxiety has diminished, but it has been replaced by another form of anxiety and that is over the potential damage to the economy as the effects from maintaining higher rates for longer grows. This week saw the second preliminary estimate of first quarter U.S. GDP. The 1.3% growth print was below the previous estimate of 1.6%, but it was driven mainly by net exports and inventories. Strip them out and real domestic spending grew by 2.8% - hardly an indication of a crumbling economy.

 

So, we have an economy that is slowing, but not contracting. Consumers haven’t yet tapped out but are in less of a position to accept higher price tags on items they can do without, thus helping to contain general inflationary pressures. And corporations continue to show a net positive surprise on earnings and even revenues. This suggests that it will have to be something external for stocks to suffer a significant correction this season. Let’s assume then that stocks continue to grind higher, then what?  This is where the 2020 comparison is useful.

 

Source: Factset Research Systems

If you recall that summer saw a huge recovery from the pandemic sell-off in March, thanks to an aggressive fiscal and monetary response to the crisis. Even though we hadn’t seen vaccines roll out, there was enough optimism that a catastrophe could be averted that money came back into the market. That was, until we got to September. Focus quickly turned to the November U.S. election and with that focus came uncertainty. While historically, the actual election result has little bearing on what happens to equity markets, the disdain for uncertainty can make for more volatile activity in the run-up to the vote. This is what happened in 2020, as circled in the chart above. Back then, we saw the potential for this increased turbulence and started to pare back equity exposure late in the summer. Markets pulled back, but then recoiled once the election was over and enjoyed more than a year of gains before hitting the 2022 wall.

 

Well, if the 2020 election was an uncertain event, I would suggest this year’s kick at the can is going to be even more indeterminate. In fact, it is hard to think of a scenario where markets skate into this vote calmly. Based on that, I believe the 2020 playbook is going to be useful. If we indeed get through the summer with a buoyant equity market, then prudency will favour taking some money off the table before the autumn. Considering that any rate cuts, if they occur, will be modest at best then investors won’t be giving up much to sit on increased cash positions in front of the vote. We can then evaluate the results and set up for 2025.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. Andrew and his clients may own securities mentioned in this column. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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