Looking Back
- Corporate earnings continued to carry markets, as we expected.
- The U.S. Federal Reserve proved as unpredictable as we anticipated, raising interest rates in September for the first time in three years.
- We flagged energy as the biggest risk to inflation easing, but underestimated how quickly oil would climb back above $100 a barrel after falling to around $70 in July.
- Gains that had been spreading across more companies narrowed again as borrowing costs rose.
- The Canadian market cooled as the trade risk we identified turned into a breakdown in negotiations.
Energy Is Driving Prices Again
- Diesel reached a record high in September. Because it moves nearly everything we buy, higher fuel costs tend to feed into everyday prices over time.
- Prices outside of energy have remained relatively steady. The pressure has a specific source, not an overheating economy.
- The Middle East conflict shows little sign of a quick resolution, and we expect energy costs to stay elevated for some time.
- We continue to favour energy infrastructure. Energy was the strongest area of the market over the quarter.
Interest Rates: Two Different Paths
- The U.S. Federal Reserve raised its rate to 3.75–4.00%, its first increase in three years, and signaled one more may follow.
- The Bank of Canada has held steady at 2.25%. Both central banks make their next decisions later this month.
- Shifting expectations for the Fed have created significant volatility in bond markets.
- Long-term rates have risen further: U.S. 10-year yields reached their highest level since 2007, and Canadian yields their highest in nearly three years.
- Heavy borrowing by governments and companies is pushing long-term rates higher, regardless of central bank policy.
- Year to date, U.S. bonds are down roughly 5.6% and Canadian bonds are down 3.2%.
Earnings Are Still Doing the Heavy Lifting
- Company profits continue to grow at a strong pace, and expectations for the third quarter rose over the summer, which is uncommon.
- Investment in artificial intelligence continues at scale. A brief dip in technology shares in September did not change the long-term direction.
- Earnings growth is expected to slow next year, which reinforces our discipline around what we are willing to pay.
Where the Major Indexes Stand
- Year to date: Nasdaq up nearly 22%, S&P 500 up 13%, TSX up 10%, and the Dow up around 6%.
- The TSX, led by energy, materials and financials, gave back ground to the technology-heavy Nasdaq in September as trade talks broke down.
- Beneath the headline numbers, the average company lagged the index and smaller companies declined over the quarter.
- A market led by a few companies is more fragile, which reinforces our focus on diversifying into strong, well-run companies.
Canada at a Turning Point
- Canada–U.S. trade talks collapsed in late August, and both countries have imposed tariffs on roughly $20 billion of each other’s goods.
- The impact is targeted rather than broad. Dairy, beverages and autos are affected, while energy and natural resources are largely untouched.
- Our committee views this as a lasting shift in how North America does business, not a temporary disruption.
- The broader economy has held up, employment remains steady, and neither the Canadian nor U.S. economy is showing signs of recession.
- The Canadian market has cooled from its summer high but remains firmly positive for the year.
How We Are Positioned
- Reduced exposure to companies that depend on selling finished goods into the United States.
- A preference for businesses serving Canadian customers, along with resources, energy infrastructure and high-quality financial companies.
- Continued exposure to the global technology leaders driving artificial intelligence, held across our mandates through the funds we use, with options strategies used where appropriate to generate income and cushion volatility.
- Canada’s push for new trading partners and its goal of attracting $1 trillion in investment over five years could create meaningful opportunities.
- Business pressure on both sides of the border, along with the upcoming review of the North American trade agreement, provides a path back to negotiations.
What We Did in Our Firm-Wide Investment Models
- Early in August, we shortened the term of our bonds, reducing their sensitivity to interest rates. That helped offset some of the bond market volatility as rates climbed through September.
- We are now shortening the term of our bonds further to reduce the volatility that comes from an uncertain interest rate environment.
- We returned equity exposure to target after a strong run, locking in gains ahead of a choppy September.
- We continue to favour government and high-quality, shorter-term bonds.
- We have seen weakness in a small number of corporate bond holdings within our income fund and SMA models, and we are reducing that exposure where appropriate.
Four Questions Heading into Year-End
- Will the U.S. Federal Reserve raise rates again, and will the Bank of Canada follow?
- Will higher energy costs spread into the prices of everyday goods and services?
- Can strong earnings continue to support a market led by fewer companies?
- Will Canada and the United States find their way back to the negotiating table?
- Key events ahead: U.S. and Canadian inflation reports, third-quarter earnings, and central bank rate decisions in late October.
- The U.S. midterm elections on November 3 will shape U.S. policy on spending, taxes and trade. Markets have historically been choppier ahead of midterms and steadier once the uncertainty passes.