Despite progress on inflation and AI stock fever, seasoned portfolio manager sees signs for caution
With two quarters in the books for 2023, the summer investing season is officially upon us. And while the rally in tech and progress in the fight against inflation have given investors reasons to celebrate, there’s still a climate of uncertainty hanging over the markets.
“This last year and a bit has been challenging. I think we’re still in a bear market,” Roderick Mahrt, senior wealth advisor and senior portfolio manager at The Mahrt Investment Group with Wellington-Altus, told Wealth Professional. “Sentiment at the moment seems to be negative to muted at best.”
Central banks’ dilemma: to hike or to hold?
Mahrt noted that inflation is moving down, but still far from the 2% target set by both the Bank of Canada and the U.S. Federal Reserve.
The economy has surprised to the upside in Canada as household spending and an uptick in exports drove annualized GDP growth of 3.1% in the first quarter, ahead of Statistics Canada’s early estimates of 2.5%. Economic growth slowed considerably in the U.S., registering a 1.1% clip, though resilience among American consumers and the country’s strong jobs market together make a case for continued optimism.
“We think that the central banks are going to hold interest rates higher for longer,” Mahrt says. “But both the BoC and the U.S. Federal Reserve could possibly raise rates one more time. For the Bank of Canada, I put the odds of them raising rates another quarter point at around 20%, based on recent numbers.”
He also highlighted the yield curve, which in December saw the widest gap between Canada’s benchmark two-year and 10-year yields in roughly 30 years. That gap has eased in the intervening months, but the curve’s continued inversion raises crucial questions about the future of the economy.
“We should never lose sight of the fact that whenever the yield curve’s inverted, that generally will lead into a recession,” Mahrt says, “albeit with the data points we’re looking at now, it could be a mild one.”
Amid AI fever, the tech-energy pendulum swings back
If there’s one bright spot in today’s markets, it would be artificial intelligence, especially generative AI and ChatGPT. Exuberance around that theme has stoked a renewed investor fever for exposure to chips and semiconductor stocks including Nvidia, which last week became the first-ever chip stock to join the trillion-dollar club.
“When you’ve seen these rallies so pronounced since the beginning of January, there’s always this fear of missing out,” Mahrt says. “From a long memory of investors herding into names like Nortel Networks, JDS Uniphase, and Blackberry, I know you don’t want to be the last man chasing the hype.
“That’s not to say this isn’t a real trend that will last for years and years,” he adds. “But sometimes these companies’ share prices get ahead of their actual buildout of new technologies, which is something we just want to be very, very cautious of.”
The advance in tech so far this year has come alongside a descent in energy companies’ valuations. That trend, Mahrt notes, represents a reversal from the 2022 dynamic of energy stocks leading the way up and tech stocks crashing to earth. More disconcertingly, he’s seeing a divergence between the S&P 500 market-cap and equal-weight benchmarks, with the market-cap index outperforming significantly since January.
“Those two indices tend to move almost in concert. But now you’ve got the 10 most capitalized companies on the S&P 500 leading the way, with the other 490 companies just going sideways to down,” he says. “Eventually, the gap between those two benchmarks will narrow. … Either the performance of those 10 leading stocks will come off, or the other 490 companies will start to move up.”
As warning signs of a potential recession flash, Mahrt emphasizes that the sectors outperforming in an economic downturn won’t necessarily be the same ones to own when the economy goes into recovery mode. That means over the next few months, it’ll be crucial for investors to do some summer homework.
“Markets tend to rally before a recession officially ends,” he says. “Our advice would be to use the summer as a time to rebalance your portfolio for the inevitable recovery.”
