BIS - Sectors To Watch With Potential Rate Cuts On The Horizon

2024-01-16 04:50:00 ET

Summary

• Why US banks could be poised for a rebound?
• Sectors primed for a pivot if the Fed cuts.
• The outlook for healthcare and real estate.

The potential for interest rate cuts this year by the U.S. Federal Reserve is raising the outlook for some sectors that had struggled in 2023. Benjamin Gossack, Managing Director and Portfolio Manager with TD Asset Management, looks at how the year may play out and the implications for investors with MoneyTalk’s Greg Bonnell.

Greg Bonnell: Signals from the US Federal Reserve that rate cuts could be on the table set off a market rally in the final weeks of 2023, marking an inflection point of sorts for several sectors. Well, here to walk us through what he's seeing in the markets, Ben Gossack, managing director and portfolio manager with TD Asset Management. Ben, great to have you back on the show.

Benjamin Gossack: Thanks. I even brought a new tie for a new year.

Greg Bonnell: So you always bring the charts, and you brought the tie for the new year, as well. Obviously, near the final innings of last year, the Fed came out and sort of tipped its hand and said, yeah, if conditions are right, we could see some rate cuts next year. We could see that ourselves, and the market took that information and ran with it, but not all of the market. You've got some interesting stuff to share with us.

Benjamin Gossack: So we definitely saw a pivot in, we'll call it, the large cap indices-- so an S&P 500, TSX 60. We saw this move and then for the full year, when we reflect back on 2023, we'll say, well, that was a great year because the S&P was up 20-something percent. Why were we sitting in cash all year?

We have been talking about a market of stocks, I think, all of 2023, and that market of stocks has actually been in a bull market, we think, for about 18 to 19 months, so that takes us back to the summer of 2022. And throughout that bull market, there has been some key pivot points. In particular, one was around March and April of '22, which was when the Feds started their hiking cycle.

We saw sectors like housing and trucking -- so these are sectors that you would think would lead an economic cycle-- outperform and still outperform. And then when the market made its bottom in November, so the S&P of that year, we saw other sectors like semiconductors make their bottom and move. With this last Fed announcement, what was notable to me were three sectors that made a pivot, and that would be banks, health care, and real estate.

Greg Bonnell: So let's talk about them, I know, because last year, you and I would have discussions about financials, but the discussion was more around the life co's having the leadership there and not so much the banks. So maybe we start walking through some of those sectors.

Benjamin Gossack: Yeah. So definitely, there's a broader secular trend that I can chart even to prior to the financial crisis of US insurance outperforming US banks. But we are in a period where we are now seeing a leadership change towards the banks. I know I brought some charts, as I normally do. I was just checking to see if they were up there.

Greg Bonnell: So here they are, financials versus the S&P 500. We got market cap weighted and equal weighted, so walk us through these charts. What are they telling us?

Benjamin Gossack: And again, just to level set or remind people, the way that we like to look at the market is to look for relative strength, so think of it as a tug of war. On the left-hand side, what you're looking at is S&P 500 financials, and that's a tug of war versus the S&P 500. It's all market cap, so you have to understand that companies like a JPMorgan (JPM) or a Berkshire (BRK.A) or Bank of America (BAC) would represent the majority of that index. And you could see 2023 was a really tough year for banks, and it's not until we get to that November, around that Fed decision, that we see a little lift. And so I'd say that's notable.

What's really interesting is-- and we've talked about this, about looking at things on an equal weight basis. So let's make JPMorgan equal to the tiniest regional bank in the index, and then let's put that over an equal weight S&P 500. And you could say-- I'd say since spring of last year, we've actually been on a 45-degree angle, but what you can't tell is about that leadership change.

So a lot of it was being driven by insurance, so you could really see the strength of insurance. And then around that Fed pivot, we saw insurance take a break, and we saw a rotation into banks. And so we have banks that are going to start the reporting season this Friday, but heading into those earnings, they're carrying some interesting momentum.

Greg Bonnell: OK. So that's a very interesting move in the financial space. You mentioned health care and real estate as well and this idea that when the Fed finally tipped its hand, despite what the market had been predicting they would do this year, some sectors woke up.

Benjamin Gossack: Yes. And then one last point on the banks. I think the reason why they're performing is you could tell that people were more worried about credit provisions and the fear of credit provisions and loans that wouldn't perform.

So that was definitely a Canadian bank story too, and I think we might have a picture of that.

And this move that we're seeing in terms of banks is that we're seeing in the US, we're seeing it in Canada. And so what we're looking at here is at the top is equal weight Canadian banks. So we treat all six Canadian banks as equal in this index, and we put it over the market cap TSX 60.

And what's really notable about Canadian banks-- and this is why, I think, so many people own Canadian banks, is that, look, banking is a cyclical sector. And when you look at this chart, you can really see that banks can go on a four-year run. So when we had the oil collapse in 2014, 2015, we saw banks depress because we were worried about their exposure to the energy sector. That fear was not warranted, and so then they went on a four-year outperformance.

And then sometimes they run into issues like banks, again, economic cycle, and they go through two years of underperformance. Canadian banks have been underperforming since, call it, the end of '21. So we've had two years of underperformance, and then just like with the US banks, we've seen a notable shift in the banks. Again, I think it's driven by the fear of the credit provision.

So I was marketing across the country. Everyone is saying, aren't we worried about the Canadian banks? All these mortgages are going to reset. Doesn't the stock market understand what's going on? And it's like, yes, it reflected that in the fear. We don't need the Fed to cut to see the benefits already because we've already seen it across the yield curve. The market has already taken a percent off rates across the board. We burrowed those rates today.

And so already, we have provided, let's say, financial pressure release across the board, and that's why you can see the banks perform now, as opposed to having to wait for a Bank of Canada cut or a Federal Reserve to cut.

Greg Bonnell: Very interesting stuff there. We went a bit deeper there on the financial stuff. I think we're going to move on to the health care space now and what you're seeing here.

Benjamin Gossack: Yeah. So on our left-hand chart, again, we're talking about market cap. What's really notable about the health care sector, it's very dominated by really big companies. So if you think about a Johnson & Johnson (JNJ) and an Abbott (ABT) and a Merck (MRK) and a Pfizer (PFE). And so in 2022, when the market was selling off, these are typically defensive areas. People have to take their medicine, have to continue dialysis, all that type of stuff.

And so you can see that in 2022, health care just outperformed. And then in '23, it was the reverse. And so those large cap companies underperformed, and most people would say in '23, health care was a bad sector to be in. But it goes back to being an active manager, doing stock selection. If you owned Eli Lilly, then you were not-- or other sort of GLP, one-type drug companies-- you were like, hey, this has been great in health care.

And it really shows up on our equal-weight chart on the right-hand side. You can see that while large-cap companies are underperforming, equal weight was steadily working, and then it stopped working. And we talked a lot about this last year in that there are lots of companies in the health care industry that were facing some existential crisis because these obesity drugs might impair their business model.

So if people who would have been disposed to diabetes don't become diabetic because their weight is under management, those are billion dollar franchises where people are saying, are you able to earn the dollars in the future that you're earning today?

Greg Bonnell: Let's talk about real estate because, our story, we want to talk about, yeah-- no, we're going to talk about real estate. We've got so much to get through.

Benjamin Gossack: There is so much to get through, yes.

Greg Bonnell: I'm getting ahead of myself, but let's talk about real estate because, obviously, when we saw aggressive interest rate hikes, there was an impact here.

Benjamin Gossack: Yeah. And so that's-- you would expect. A lot of times, you're looking at the market and you're like, I expect certain things to happen. You see it, and you're like OK, not surprised. And sometimes you look and you're like, hey, I expected something. I didn't see it happen.

With real estate, very bond-like. We saw interest rates go up. We saw real estate underperform. Throw on top of that issues with office, issues regarding commercial real estate, all that type of stuff, a wall of debt, all that type of stuff. Yes, it's just fuel on the fire. It's underperformed. We're seeing a turn in US real estate sector, and I see it on market cap and equal weight.

So it's not just one or two stocks that are moving. It's all stocks are moving. Not only that, Greg, I see it in Canada, and I see it in Europe. It's a global phenomenon where real estate had underperformed, and it pivots. Now, if I look at those charts, they seem to be in secular decline, and so it's very possible that what we're seeing in real estate is, yeah, we declined. We're going to unwind, and we could continue that decline.

So I'm not saying there's going to be some bonanza in real estate, but it does look like there is a relief rally tied to the fact that interest rates have fallen.

Greg Bonnell: A lot of those charts have something in common where we saw where the Fed came in, stepped in, changed the market's thinking about what they might be up to this year, the inflection point. We are told that telecoms and utilities are also very rate sensitive. They didn't appear to wake up, I think, from the charts you're going to show us. What's going on there?

Benjamin Gossack: And that's why I find even more notable. There's stuff that you would expect. You see it show up on the chart, and you're like, yeah, the market is doing what you would expect it to doing. I find it more fascinating when you expected a result and you saw something else happen. So we've seen staples decline even more. We've seen utilities decline more and telecom stocks.

And you would think, well, they were declining all this time before. The narrative was, yes, this is being driven by interest rates. So we lower interest rates across the yield curve by 1%. We see certain sectors perform, and then these ones got worse? And so now, it's just like, what's going on? And that's something that I continue to ask myself. Why aren't they participating?

And I don't have that answer right now, but that's the beauty of looking at charts, looking at patterns. I find they're not crystal balls, but they help you to direct where to focus and where to ask the right questions.

Original Post

For further details see: