1) INTRODUCTION:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #66!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
Our topic for today will be the review of performance of capital markets for the first half of 2024.
Enjoy!
2) 2024 MID-YEAR CAPITAL MARKETS REVIEW:
François Doyon La Rochelle:
Before we start, we thought of rewarding our regular listeners with a prize. All of you are eligible, we will have more details at the end of today’s podcast.
Now, I will start to cover today’s topic which is the mid-year review of the global capital markets performance for the first half of 2024. Our regular listeners know that we cover this topic twice yearly to help them better understand and evaluate their portfolios’ performance.
James Parkyn:
Yes, and François since we will be going over a lot of data points from our market statistics report, I would like to remind our listeners that the report can be found on our Capital Topics website page in the resources section, or it is available on our team’s page on the PWL Capital website.
François Doyon La Rochelle:
Indeed, James and I would add that our listeners can also find the performance of our model portfolios on the Capital Topics website again in the resources section or directly on our team’s page on the PWL Capital website.
Now let’s move on to our topic. If you have listened to our last podcast #65 on how to invest when markets are making new all-time highs, you know that 2024 is off to a great start.
James Parkyn:
Indeed, François, it has been a great first half in 2024, This follows strong market returns in 2023, especially in the U.S. stock market. Our listeners may recall that in 2023 the S&P500 returned 15.8% in the last two months of the year, in U.S. dollars.
François Doyon La Rochelle:
Yes, and these strong results came despite a load of economic and geopolitical uncertainties. On the economic front, stubborn inflation above central banks' comfort levels meant that interest rates would stay higher for longer and that these prolonged higher rates would eventually negatively impact economic activity. Market pundits were speculating around the prospect of a soft landing or a recession.
James Parkyn:
Yes François, but despite these fears, gross domestic product growth rates are still positive in Canada, the Euro Area, and the U.K., and somewhat stronger in the U.S. On the geopolitical front, uncertainties continue. Russia is still at war with Ukraine, and Israel’s conflict with Palestine is ongoing. We are also seeing more and more geopolitical fragmentation with a resurgence in the competition amongst rival superpowers, China and the U.S. On top of that, there were important elections in major global powers such as the U.K., France, Taiwan, and India. And finally, closer to home, the U.S. election campaign is in full force, with incredible ups and downs, the two sides are deeply entrenched, and the outcome is uncertain.
François Doyon La Rochelle:
James, as always there is plenty to worry about but as the popular saying on Wall Street goes, the bull market has been climbing a wall of worry. This being said, there was still some good news on the economic front. Inflation rates have declined worldwide enabling some central banks to start cutting interest rates. Here in Canada, the inflation rate has declined from 3.4% in December 2023 to 2.7% in June and recently, the Bank of Canada cut its central bank rate from 4.75% to 4.50%. In the U.S., the inflation rate has also declined from 3.4% to 3% but the Federal Reserve has yet to cut its target rate as it remains at 5.5%.
James Parkyn:
I would add François, on the inflation front in the U.S., it appears that the Federal Reserve is now much closer to cutting interest rates, considering the most recent inflation rate news. Expectations earlier this year were that the Fed would cut rates several times during the year but in the last Federal Reserve meeting the Fed signaled only one rate cut. Globally, inflation news has been getting better and inflation appears under control, dropping from 2.9% to 2.5% in the Euro Area, and from 4% to 2% in the UK. The drop in inflation in the Euro Area prompted the European Central Bank to cut rates from 4.0% to 3.75%.
François Doyon La Rochelle:
I think James that it’s fair to say that the inflation rates are under control and that rates are close to the Central Bank’s target of 2%. We can also add that Central Banks have moved from a globally coordinated effort to fight inflation by swiftly hiking rates to a phase of rate cuts that will be more sporadic and intermittent reflecting each domestic economic situation.
James Parkyn:
I think you are right Francois, I’m not an economist but I think Central Banks will adjust their rates based on prevailing and evolving domestic economic data.
François Doyon La Rochelle:
Now let’s look at the market statistics for the first half of 2024. Again, as a reminder our market statistics can be found on our Capital Topics’ website and in our team’s section on the PWL Capital website. We will provide the link for the market stats with the podcast page.
Starting with the fixed income, the yields in Canada and the U.S. remain well above the average yields available in the last 20 years. In Canada, the yield on the 10-year Government of Canada bond was on June 30th at 3.5% which is 100 basis points above the 20-year average of 2.5%. In the U.S., the yield on the 10-year Treasury note on June 30th was roughly at 4.4% which is 140 basis points above the 20-year average of 3.0%.
James Parkyn:
Since yields are above multi-decade averages and inflation is getting back to normal, I think that it could be a good time to reflect on your bond allocation. I’m saying this because when rates were low, a lot of investors increased their exposure to risky assets to increase returns but now that rates, as we have been highlighting in our podcast “normalized” and equity have done so well, it could be a good time to derisk your portfolio. I’m not proposing this as a tactical, short-term move but really as a long-term strategic portfolio decision.
François Doyon La Rochelle:
I guess James, what you’re trying to say, this advice is not about market timing. To be more precise, I believe James what you’re proposing is that investors should do a review of their risk capacity and take advantage of much better interest rates, as they derisk their portfolio.
James Parkyn:
Correct François especially considering the extraordinary performance delivered by the stock markets, since September of 2022. I think investors should ask themselves the simple question of how they would react in the next bear market, which cannot be predicted. If you think you can stay the course, then there may be no reason to make any changes.
François Doyon La Rochelle:
Coming back to the performance of bonds, Canadian short-term bonds were up 1.6% as of June 30th, and the total bond market, which holds longer-dated maturities was down by 0.4% due to a slight increase in the yields of longer-dated bonds. You need to remember that bond yields and bond prices move in opposite directions. For the last year, Canadian short-term bonds have also outperformed longer-dated bonds with a performance of 5.6% compared to 3.7% for the total bond market.
James Parkyn:
François, I think we should highlight that investors have lost money on their bonds over the last 5 years. From our market statistics page, you can see the impact of the historical downturn in the market in 2022. The Canadian total bond market returned a negative 0.05%, and that’s before inflation. Considering that inflation for that period was 3.4% annually, investors on a real return basis lost significantly more.
François Doyon La Rochelle:
Correct James, but again these returns are for the Canadian total bond market, which holds longer-dated bonds. For investors, like us, who use short-term bonds with maturities of 1 to 5 years, the annual performance over the last 5 years was 1.4%.
James Parkyn:
Ok, Francois, that was for the bond market, but what happened in the equity markets?
François Doyon La Rochelle:
Looking at the equity markets around the globe, all the main indexes we follow have had strong positive returns in the first half of the year.
James Parkyn:
I would add François, as we mentioned in our last podcast, many of them are making new all-time highs. This has been particularly true in the U.S. with the S&P500 Index. This index made an incredible 31 new all-time highs in the first half of the year. Other global markets like the S&P/TSX Composite Index here in Canada and the MSCI EAFE Index for developed markets have also reached new all-time highs so far this year.
François Doyon La Rochelle:
Indeed, James but the only main index we follow that has not made new all-time highs this year is the MSCI Emerging Markets Index.
James Parkyn:
Yes, this index has been impacted by the poor performance of Chinese equities over the last three years or so. Chinese equities currently represent roughly 25% of the MSCI Emerging Market Index and their poor performance has weighed down on this index. Incredibly Chinese equities are down close to 42% from their all-time high.
François Doyon La Rochelle:
Getting back to Canadian equities, the S&P/TSX composite was up by 6.05% in the first half. Large and mid-cap growth stocks led the way with a performance of 7.4% compared with 4.7% for large and mid-cap value stocks. Small-cap stocks outperformed large and mid-cap stocks for the period with a performance of 9.3%. For the last year, the S&P/TSX Composite had a total return of 12.1%, which is considerably higher than the long-term expected return.
James Parkyn:
And now François, what about the U.S. equities?
François Doyon La Rochelle:
Well, James, U.S. equities have been on a tear in the first half of the year. The S&P500 Index had its 13th best yearly start since 1950 and as you mentioned James, it has reached multiple new all-time highs. Looking at the details, the U.S. total market index has had a strong performance of 13.6% in U.S. dollars and 17.2% in Canadian dollars. The difference in performance is due to the Canadian dollar losing ground versus the greenback for the period. If you have been following the headlines you will not be surprised to hear that large and mid-cap growth stocks had an extraordinary performance as of June 30th of 24.6% in Canadian dollars compared to 10.1% for large and mid-cap value stocks. Small-cap stocks, however, underperformed their larger counterparts with a performance of 5.1%. Over the last 12 months, the performance of the U.S. total market index is even better with a performance, in Canadian dollars, of 24.2%.
James Parkyn:
As our regular listeners know, this strong performance has been driven mainly by artificial intelligence stocks (AI) and other technology stocks that are leading the way in the U.S. equities. According to Morningstar roughly 62% of the return in the first half was due to seven stocks, Alphabet (Google), Amazon, Apple, Microsoft, Meta (Facebook), NVIDIA, and Broadcom.
François Doyon La Rochelle:
At the beginning of the year, there was hope that the rally would broaden up beyond large-cap technology stocks, but it appears it hasn’t yet. This being said James, when you look at our market statistics page you will notice that large & mid-cap value stocks have still been delivering very decent returns. Their performance may appear lackluster compared to growth stocks but over the last year they still returned 16.8% (in Canadian dollars) and over the last decade almost 11% annually. These are very good returns; they only appear weak when compared to the outsized performance of large and mid-cap growth stocks, which have returned 37.8% in the last year and 19.3% annually over the last decade.
James Parkyn:
I agree with you Francois, looking at the PWL estimates for long-term expected returns, the recent performance of large and mid-cap growth stocks is way off the charts. We have to wonder how long this outperformance will persist. The noise in the financial media, from market analysts, is that valuation levels are stretched and are vulnerable to a major correction.
François Doyon La Rochelle:
Finally, looking at internationally developed equities, large and mid-cap stocks as we mentioned were also up year-to-date, they were up by 11.1% in local currency. In Canadian dollars, international developed equities were up 8.8% since the Canadian dollar appreciated against the basket of currencies included in the MSCI EAFE Index. Here again, large and mid-cap growth stocks have outperformed value stocks but by a smaller margin with a performance of 9.7% in Canadian dollars compared to 7.9% for large and mid-cap value stocks. Small-cap stocks are however trailing their large and mid-cap counterparts with a performance of 3.8%.
To conclude, emerging market stocks are also performing well with a year-to-date performance of 11.2%, and similarly to developed markets value and small-cap stocks are trailing growth and large-cap stocks.
James Parkyn:
It’s pretty clear to me Francois, from these market statistics that investors need to review their exposure to large and mid-cap growth stocks in the U.S. That being said, I would recommend our listeners to be weary of one of the most common cognitive errors that investors make, which is recency bias. This is the tendency to put too much emphasis on the latest performance trends which leads investors to deviate from their long-term investment plan. Therefore, please keep this in mind when reviewing your portfolios.
François Doyon La Rochelle:
I agree James, market trends change over time. For the last few years, U.S. growth stocks have outperformed but it will not always be the case. Investors need to stay disciplined in their long-term investment plans based on their goals and objectives and not let the latest market trends lead them astray. Investors need to stay diversified globally and have exposure to academically proven market premiums such as small-cap and value stocks because you never know when the tide will turn.
3) CONCLUSION:
François Doyon La Rochelle:
Thank you, James Parkyn: for sharing your expertise and your knowledge again today.
James Parkyn:
My pleasure. François.
François Doyon La Rochelle:
Before I conclude this episode, as promised, we have a surprise for our listeners. We have tickets for the Omnium National Bank tennis tournament in Montreal that we would like to giveaway. The tickets available are for the qualifying sessions on Monday August 5th starting at 11:00AM. So, if you are interested, please email us at capitaltopics@pwlcapital.com. It’s first come first serve so hurry fast, we have four pairs of tickets with parking passes to giveaway.
That being said, that’s it for episode #66 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: capitaltopics@pwlcapital.com
Also, if you like our podcast, please share it when with family and friends and if you have not subscribed to it, please do.
Again, thank you for tuning in and please join us for our next episode to be released on September 25th as we will be taking a break for summer holidays. In the meantime, make sure to consult the Capital Topics website for our latest blog posts.
See you soon.