By Scotia Wealth Management

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Market Watch: July 26

Jul 29, 2024 | 11:13 AM

This week’s highlights

• Megacap tech and chip stocks continue to weigh on equity markets
• Bond yields mixed following release of Fed’s preferred inflation gauge
• Bank of Canada cuts key rate to 4.5%, tees up additional easing
• U.S. economic growth regains momentum in second quarter as inflation slows
• Eurozone PMI composite hits 5-month low
• In the news: Chip stocks face setback despite strong demand

Week in review

Megacap tech and chip stocks continue to weigh on equity markets

Global indices closed out a turbulent week of trading amid a volley of U.S. economic news, with investors paying close attention to any data that could inform the timing of interest rate cuts while keeping a close eye on tech stocks after the prior weeks pullback. Markets were modestly up for the week until Wednesday when both Alphabet and Tesla reported mixed earnings, stirring worries that big tech may no longer be able to fuel the outsized gains they have become synonymous with. Following that, a strong U.S. GDP reading on Thursday also weighed on investor sentiment as expectations for a rate cut were pushed back to September. However, on Friday, the Federal Reserve’s (Fed) preferred gauge of inflation assuaged some concerns but not enough to push the index back into positive territory after it showed inflation was in line with expectations.

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Highlights

• U.S. markets were -0.82 per cent¹ lower for for the week as megacap tech names and chip stocks pulled the broader index lower as investors continue to take some profits and rotate into small caps amid policy normalization expectations.
• Canadian markets returned 0.60 per cent² for the week with rate sensitive sectors such as financials, utilities and real estate driving much of the week’s returns following the Bank of Canada (BoC) interest rate cut.
• European markets returned -0.86 per cent³ for the week, with markets reacting positively to U.S. inflation news and recouping some of the losses incurred earlier in the week.
• Emerging markets closed 0.33 per cent⁴ higher despite trading lower for most of the week as China’s stimulus measures – so far mostly confined to industrial output – failed to convince investors it can revive the economy and support markets.

Bond yields mixed following release of Fed’s preferred inflation gauge

U.S. short- and long-term rates were mixed for the week but moved lower Friday following the release of June inflation numbers as measured by the Personal Consumption Expenditure (PCE) price index that matched expectations. The report strengthened the argument for a rate cut in September, just before the Fed’s meeting next week. While the central bank is expected to keep interest rates steady at the July meeting, investors are looking for clearer indications of the timing and number of rate cuts anticipated this year. Futures markets are still pricing in a rate cut for September, followed by a second one by year end. Credit remained firm for the week after spreads widened late in the week, investment-grade in particular.

Highlights

• The 2-year U.S. Treasury yield was 4 basis points (bps) lower while the 10-year yield was up 4 bps. In Canada, the 2- and 10-year yields were 7 bps and 1 bp lower, respectively.
• The Commerce Department’s report on Friday revealed that June PCE increased by 0.1 per cent for the month and rose by 2.5 per cent compared to the same period last year, matching economists’ expectations.
• According to data compiled by Bloomberg, primary market volume has outpaced expectations every month this year as issuers look to borrow before the November U.S. election potentially brings higher volatility to bond markets.

Weekly Dashboard

Bank of Canada cuts key rate to 4.5 per cent, tees up additional easing

The Bank of Canada lowered its benchmark interest rate for the second consecutive time and said that it is now putting more emphasis on downside risks to economic growth rather than focusing mainly on the risk of a rebound in inflation. The widely anticipated move brings the bank’s policy rate to 4.5 per cent from 4.75 per cent. This is the second cut in a long-awaited monetary policy easing cycle and comes after the bank raised interest rates 10 times in 2022 and 2023 to tackle the most serious bout of inflation in a generation.

Highlights

• Price pressures have eased as global supply chains have improved, economic growth has stalled, and restrictive interest rates have curbed consumer spending, which has all led the bank to adopt a more balanced approach to monetary policy in its latest rate decision.
• “As inflation gets closer to the 2 per cent, the risk that inflation comes in higher than expected has to be increasingly balanced against the risk that the economy and inflation could be weaker than expected,” Bank of Canada Governor Tiff Macklem said.
• Macklem said it is “reasonable” to expect additional rate cuts if inflation continues trending lower, as the central bank is forecasting. However, he said the bank’s governing council will be “taking our monetary policy decisions one at a time.”

U.S. economic growth regains momentum in second quarter as inflation slows

The U.S. economy grew faster than expected in the second quarter, but inflation subsided, leaving intact expectations of a September interest rate cut from the U.S. Federal Reserve (Fed). Gross domestic product (GDP) increased at a 2.8 per cent annualized rate last quarter, the U.S. Commerce Department’s Bureau of Economic Analysis reported in its advance estimate of second-quarter GDP. Economists had forecast GDP rising at a 2.0 per cent rate. The economy grew at a 1.4 per cent rate in the first quarter. U.S. central bank officials regard a 1.8 per cent pace as the non-inflationary growth rate.

Highlights

• The economy, which continues to outperform its global peers despite hefty rate hikes from the Fed in 2022 and 2023, remains supported by a resilient labour market even as the unemployment rate has risen to a 2-1/2-year high of 4.1 per cent.
• The personal consumption expenditures (PCE) price index, excluding the volatile food and energy components, increased at a 2.9 per cent rate after surging to 3.7 per cent in the first quarter, welcome news for U.S. central bank officials.
• The Fed has maintained its benchmark overnight interest rate in the current 5.25 per cent-5.50 per cent range for the past year. It has hiked its policy rate by 525 basis points since 2022. Financial markets expect three rate cuts this year, starting in September.

Eurozone PMI composite hits 5-month low

The eurozone composite Purchasing Manager’s Index (PMI) declined to 50.1 in July from 50.9 previously, slightly above the 50 threshold that separates an expansion from a contraction. Output has risen in each of the past five months, but the pace of expansion appears to be slowing. The manufacturing sector was a weak spot, with the underlying PMI dropping to 45.6, continuing the trend of sub-50 readings. The pace of contraction also accelerated to the fastest since the start of the year. While services activity also slowed, with the PMI declining to 51.9, the sector was healthy enough to offset the weakness seen in manufacturing.

Highlights

• The two largest eurozone economies underperformed the rest of the region. Germany’s composite PMI contracted for the first time in four months, while France posted a third consecutive monthly reduction in business activity. Employment was unchanged across the eurozone in July, ending six months of job creation.
• The report also highlighted that selling prices increased at a slower pace as falling demand caused companies to reduce prices. However, input cost pressures remained persistent, posing a risk to profit margins.
• The report echoed the European Central Bank’s (ECB) view that risks to the economic outlook are tilted to the downside over the medium term, and the market increased the odds of a September policy rate reduction from the ECB.

In the news: Chip stocks face setback despite strong demand

Chip stocks, which have heavily contributed to market performance over the past year, declined significantly this past week. Several factors contributed to this correction. Firstly, the U.S. is considering tighter restrictions on exporting chip-making equipment to China, extending efforts to limit China’s advanced chip production. Second, former President Trump, running for re-election, suggested Taiwan should pay the U.S. for its defense and accused it of harming the U.S. semiconductor industry. Finally, investors are shifting from tech stocks to smaller companies due to broader macroeconomic trends; recent CPI and PCE data showed cooling inflation, reinforcing expectations that the Federal Reserve will cut interest rates in September, benefiting smaller companies.

Behind the headline

• Stocks with prolonged outperformance and high P/E multiples – which many of the mega-cap chip stocks exhibit – can be more vulnerable to corrections when negative news arises, as their elevated valuations make them more sensitive to shifts in investor sentiment.
• Big names in the semiconductor space such as Nvidia, ASML Holding, Arm Holdings and Taiwan Semiconductor Manufacturing Company (TSMC), were down -6.17 per cent, -4.26 per cent, -9.98 per cent and -4.25 per cent, respectively, for the week.
• Even if some or all of these risks were to materialize, demand for and sales of advanced semiconductors are expected to remain strong, with top-line growth figures projected to be in the double-digits for the next several years.

Carry On?

This week’s risk dashboard:

• Kamala Harris represents her own set of policy risks
• Summer’s last great central bank blow-out
• Will the FOMC signal more confidence to cut?
• The vulnerable carry trade…
• …has markets on BoJ hike watch…
• …amid expectations it will slash JGB purchases
• The BoE’s ‘finely balanced’ cut or hold choice
• US nonfarm payrolls still resilient?
• Canada’s economy to exit Q2 softer…
• …but my longstanding resilience bias remains intact

Read the full publication here

• Eurozone inflation to begin informing the ECB’s September choice
• Eurozone economy could eke out slow growth
• Three LatAm central banks decide on Fed day…
• …with BanRep is expected to cut…
• …BCCh is a closer call…
• …and BCB is expected to remain on hold
• ‘Big tech’ earnings risk
• RBA hike risk to be informed by CPI
• Mexican GDP growth to pick up
• China’s PMIs likely to reaffirm slight growth
• Other global macro

¹ S&P 500 Index CAD
² S&P/TSX Composite Index CAD
³ Bloomberg Developed Markets ex N. America Large & Mid Cap Price Return Index CAD
⁴ Bloomberg EM Large & Mid Cap Price Return Index CAD

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