The days are starting to feel more autumn-like as we bring our coats out from their closet hibernation and, after weeks of resistance, trees are finally starting to shed their foliage. But, while the temperatures are a little chilly, equity markets are generally still on the boil, even though the U.S. election is less than three weeks away and there is no clear path towards resolution in the Middle East. As we head towards November, let’s have a look at what economic and market factors appear to be unchanging and which are starting to take different paths.

We can begin with a story that has remained consistent for weeks now and that is the disinflation in North America and elsewhere around the globe. This week, Statistics Canada reported that headline CPI inflation fell to 1.6% in September – the first time we have seen inflation below the Bank of Canada’s 2% target since February 2021 – as the chart below shows. Core inflation remained at 2.3% but did not detract from the victory celebrations in Ottawa.

On a monthly basis, consumer prices fell by 0.4% after a 0.2% decline in August. This is also the first time we have seen back-to-back months of falling prices since the summer of 2020 and underscores just how much weaker the Canadian economy is this half versus the U.S. Next Wednesday, the Bank of Canada will once again decide on where to set its target rate and the data supports at least a fourth straight quarter-point cut. After this week’s CPI report, however, there was a greater call for a 50-basis point move.

This is music to the ears of bond bulls and the 2yr Government of Canada yield fell to below 3% mid-week and the 10yr retraced back to 3.1%, partially recovering the ground lost since the middle of September. As I discussed the other week, the September and early-October sell-off in bonds was but a speed bump on a road to lower yields. The inflation data cements that in my opinion, which is why it makes sense now to not only trimming floating rate exposure but exiting.

Well, if CPI was music for bonds, it was a cattle call for the exit doors for the Canadian dollar. A slip in core commodity prices this month (excluding precious metals) hasn’t helped the Loonie and has prevented further advancement through the 75 US cent level, but CPI was a kick in the pants. On an intraday basis, the currency hit a low of 72.25 cents on Tuesday but has since recovered back above 73 cents as shown in the chart below.

It wasn’t just the Canadian dollar that felt a bit of a chill this week. While the beginning of the third quarter earnings season looked to be getting off on the right foot, along came the cold water when Dutch chipmaker ASML lowered its guidance for the rest of the year, reported orders in the third quarter were less than half of what analysts had expected. Many won’t ascribe the same household name status to this company as say Nvidia, but ASML has a virtual monopoly in advanced chip-making machines. As such, investors heard the news and ran for the exit doors. The stock price fell by 15% on Tuesday afternoon and this had a ripple effect across the other major chipmakers, as well as Nvidia.

Yet, in a replay of the same show we saw back in July and early September, when investors started to doubt the remaining strength of the AI-powered engine, we get a reminder that everything is okay. Taiwan Semiconductor Manufacturing Co (TSMC), the world’s largest chipmaker, reported a 54% increase in profits last quarter and said that demand for chips used in AI remains extremely strong. That was all the street needed to hear to switch from despair to optimism again. As markets opened in NY, the American Depositary Receipts (ADRs) for the stock were up north of 12% and helped the Philadelphia Semiconductor Index to a gain of 2% - not enough for a full recovery back to last week’s highs, but if we see decent results from the remaining firms, then the technical pattern of higher highs and higher lows since September could remain intact.

A relief rally in tech notwithstanding, the more positive development this month has been the improved breadth of the equity bull market. U.S. banks have led off the third quarter earnings season with numbers that have also beat market estimates. We saw stronger profits from JPMorgan, Wells Fargo, Goldman Sachs and Bank of America, driven by capital markets performance and wealth management. Looking at a fairly passive vehicle, like the BMO Equal Weight US Banks Index ETF (ZBK) in the chart below, you can see that the sector has recovered more than 50% of the total value lost between the peak in January 2022 and May of last year.

The caveat is that most banks also increased their loan loss provisions from where they were last year, suggesting reduced optimism in where the economy is headed. Considering the slower growth in employment in recent months and borrowing costs that are still elevated, this is a prudent course of action for the banks. That said, the numbers we have seen on the economy this past week do not point to an economy in trouble.

The Philly Fed Business Index, a barometer of manufacturing sentiment in the Fed’s Philadelphia district, came in much stronger than predicted this month with a reading of +10.3. This is the third best level since the index fell into a technical contraction phase when the Fed started hiking rates in 2022. The 6-month outlook index more than doubled to 36.7 and new orders jumped to 14.2. On the consumer side, there was also evidence that things aren’t as gloomy as some have feared.

Retail sales for the month of September rose by 0.4% on the month, versus calls for a 0.3% rise, while sales excluding autos rose by 0.5%. The control group, which is closely watched by the Fed, is total sales minus building materials, food, gasoline station stations and autos. In the chart above, you can see that this measure saw a monthly increase of 0.7% in September, which was more than double what economists had expected. It also follows a healthy 0.3% gain in August, implying that overall consumer spending in the third quarter is likely to be as strong as what we saw in the second, with annualized growth close to 3%.

On net, I would have to say that fundamentals remain supportive for equities as we finish this month. Rate cuts in Canada look like a given, which should continue to be positive for Canadian dividend stocks. Economic data in the U.S. has taken a 50bp rate cut off the table for November, and some even doubt a quarter-point move, but if inflation remains on a downward path, the Fed can continue a steady 25bp per meeting agenda into next year. There are still post-election risks to contend with, like where fiscal policy is heading, and we can’t take our eyes off the Middle East, but as Octobers go, this one hasn’t been too bad at all.

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

Andrew Pyle