Market and economic commentary
July 2024

July was a positive month for nearly all major markets worldwide as continued talks of rate cuts amid falling inflation led to falling yields and stocks rising. An unexpected drop in headline US CPI seemingly caused a rotation in equity markets out of popular mega-cap stocks and into small- and mid-cap equities. All Compass Portfolios and ATBIS Pools (the Funds) saw positive returns for the month. Find up-to-date performance data here.

Below are index total returns in Canadian dollar (CAD) terms for July and year-to-date, respectively:

Economics

Headline US inflation was front and centre for the month. Prices on a month-over-month basis fell 0.1% in June—the first time since the start of the pandemic—surprising market observers who were calling for an increase of 0.1%. Core inflation also came in lower than expected, and coupled with an employment market that appears to be moderating, a September rate cut seems more probable, barring any unexpected spikes in inflation.

The US Federal Reserve (the Fed) noted in its July rate decision that there has been "some further progress" towards their inflation target while also saying it doesn’t "expect it will be appropriate" to lower rates until it has more confidence inflation is moving towards target. This implies that the Fed isn’t seeing all the data it needs to come close to pulling the trigger on rate cuts. That said, a "data-driven" Fed can change its opinion quickly, causing knee-jerk reactions in markets to economic data releases that might sway its decisions.

In its July meeting, the Bank of Canada (BoC) cut rates by another 0.25%, lowering the overnight lending rate to 4.5%. The BoC noted that potential output is still growing faster than GDP, leading to more excess supply. Per capita GDP is expected to continue to fall as GDP, while higher than expected for May, is still likely lagging behind population growth.

The unemployment rate continued to tick up, at 6.4% for June. While at first glance, an increase of 0.6% since the beginning of the year may be cause for concern, the number of jobs has actually grown on a year-to-date basis, pointing to the increase in population as a cause for the uptick in the unemployment rate.

Headline inflation also saw a month-over-month decrease in June, to much less fanfare than its US counterpart. Overall, the BoC’s decision was expected, and markets are currently pricing in two more cuts by the end of the year, but much can change very quickly in a "data-driven" regime.

Markets

As core inflation continued to show signs of easing, Canadian bond yields dropped 0.36% overall over the month, as measured by the FTSE Canada Bond Universe. The decrease was felt across the curve—bonds with the longest duration benefitted the most despite yields on that end of the curve falling the least. The move in yields elevated year-to-date returns for the FTSE Canada Bond Universe to 1.9% at the end of July, from -0.4% to the end of June. Spreads were largely unchanged, leading to government bonds outperforming their corporate counterparts, as corporate bonds tend to have lower durations. A combination of higher weighting in corporate bonds and shorter duration led to the fixed income holdings within the Funds to slightly underperform against the benchmark, remaining higher on a year-to-date basis. 

Renewed optimism for sooner-than-later rate cuts boosted stocks in all major developed markets, especially within small- and mid-cap equities. A rotation out of mega-caps, particularly growth companies, led to the S&P 600 Small Cap index outperforming the large-cap S&P 500 index by just under 9.6%. Earnings growth within the small-cap space has been outpacing their large-cap peers since the onset of the pandemic, leading to multi-decade valuation differentials, so the outperformance is not without merit. The pace at which small-cap equities rose over the month is unexpected, but continued lower inflation has seemed to spark sudden investor enthusiasm within the space.

Falling yields and expectations for lower rates resulted in the more debt-heavy and defensive sectors, such as utilities and real estate, leading developed market indices in North America and overseas.

The communication services and information technology within the US market sectors lost ground over the month—two sectors in which we are underweight—leading to our active holdings outperforming the benchmark. Overall, our overweight within small- and mid-cap stocks within the US holdings versus our benchmark further enhanced performance.

Internationally, favourable selection within industrials and consumer discretionary stocks outweighed our lack of holdings in outperforming real estate and utilities.