Chipmakers Soar, Interest Rates Stall

Weekly Commentary

Market Recap

• Equity markets were mixed this week, with some big moves in the tech sector helping the broad U.S. indices, but an unresolved debt limit standoff still weighing on sentiment.
• The S&P 500 added 0.3%, powered by a 5% surge in tech, while the TSX gave back 2.1% as banks lagged.
• Nvidia’s AI-fueled surge caught attention this week, but a handful of big tech and communication services names have been doing almost all the work in propping up equities this year.

Interest Rates

With the U.S. Federal Reserve (the Fed) teasing a rate hiking pause for July, some optimistic investors believe that rate cuts are on the table this year. Our view, however, is that it remains an unlikely outcome. Recent economic data has shown a gradual slowdown in growth, including some job losses and/or the expectation of layoffs down the road. But we haven’t yet seen massive unemployment or a major downturn of the economy, which is what it usually takes for consumers to turn off the taps. Without a drop in spending, inflation is likely to remain above the 2% target—and, as long as that’s the case, it will be difficult for the Fed to cut rates. They will, however, be able to make a case for pausing on the basis that previous rate increases need a chance to filter into the economy. A look at the calendar provides a possible timeline. We’re now approaching the end of May, and recession effects can often take six months or more to appear in data, which would take us through to the end of the year. That tells us that rate cuts are very unlikely in 2023, and a dubious possibility for the first quarter of 2024. There’s also the question of the length of a possible recession—our belief is that it will be short-lived, but we won’t know for sure until we get closer to the end of the year, and of course that would affect the Fed’s timing. And it’s also worth noting that within the Fed itself, there simply don’t appear to be many voices calling for rate cuts any time soon.

Bottom Line: Until job losses and wage declines cause consumer spending patterns to change, there’s little rationale for rate cuts.

Nvidia

Last week, Nvidia’s shares surged after their latest earnings announcement, prompting the question—is this an outlier or a bellwether for other chipmakers? But taking a step back, Nvidia’s success underscores our stance that Quality companies are what investors should be focusing on in a declining economy. The company significantly outperformed Wall Street’s estimates and placed a big focus on artificial intelligence (AI), which has been the story of the year both in markets and beyond. Those factors, combined with strong management and execution, make it no surprise that Nvidia would do exceptionally well even with the company’s stock having already run up significantly this year. In general, we view Nvidia’s surge as positive sign for other chipmakers; from gaming to automotives, microchips are becoming increasingly important in our day-to-day lives. But the fact that AMD’s results weren’t as strong as Nvidia’s speaks to the difference between good performance and great performance, with markets preferring Quality companies executing at the highest levels.

Bottom Line: In this environment, it’s Quality that is driving markets, and Nvidia is the unquestioned leader in the chip space.

Canadian Banks

Five of Canada’s Big Six banks released their second-quarter earnings last week, with all but one failing to beat analysts’ expectations. Given that markets have been down and housing activity has been lower, we weren’t surprised to see pressure from a year-over-year perspective. But it’s important to remember that balance sheets are still strong, which means that dividends are likely to remain good—BMO, in fact, increased its dividend, which is an indicator of positive momentum. We view Canadian banks as part of a long-term, core strategy. They are solid companies with tremendous consumer bases and a history of dividend increases. The only minor asterisk is that the housing market has been deteriorating, and while we may be nearing a bottom in Canada, the credit situation is still tight and consumers may not be eager to start buying homes again. That could create a short-term drag on earnings. But investors own banks for the long haul, and the thesis hasn’t changed.

Bottom Line: Canadian banks remain an attractive long-term investment.

Positioning

A detailed breakdown of our portfolio positioning is available in the latest BMO GAM House View Report, titled Are the Bears Ready to Hibernate?

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Originally Posted May 29, 2023 – Chipmakers Soar, Interest Rates Stall

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