EQUITIES COMMENT – “HAVES” & “HAVE-NOTS”

Karl Marx was the first to use the term “have-nots” which are typically people with little money and few possessions.  On the other hand, the “haves” are a privileged class with abundant resources and property.  Stock markets today share some features of “haves” and “have-nots”.

During the second quarter, the S&P 500 was one of the “haves”.  It rose 4% in Canadian dollar terms.  Continued strength in Technology related stocks like the Magnificent 7--Apple, Amazon, Alphabet (Google), META (Facebook), Tesla, Microsoft and NVIDIA--boosted the index.  These companies are investing heavily in Artificial Intelligence (AI) with the expectation that the payoff will be substantial.  The TSX Composite falls into the “have-nots” group.  It was down 1% during the second quarter.  Copper and silver were up and this supported the index however, limited exposure to AI stocks held back the results.  

When we look at the year to date sector performance, there are clear “haves” and “have-nots”.  S&P 500 Technology stocks were up 28% versus TSX Technology at -1.1%.  The S&P 500 Communications sector (includes META and Alphabet, AI leaders) gained 26% whereas the TSX Communications sector was down 15%.  The Canadian Communications stocks are being pummelled by a combination of intense competition from smaller companies trying to gain market share, negative regulatory decisions and pressure from higher interest rates.   TSX Materials (which contains mining stocks) was up 13% while the S&P 500 Materials stocks rose only 3%.  In Canada, the Materials sector is heavily exposed to mining which benefitted from higher commodity prices.  The S&P 500 Materials sector is weighted towards chemicals which eked out a small gain.  In both regions, Energy was a “have” (higher oil prices) whereas Real Estate was a “have-not” (high interest rates and office vacancy rates).

The ”haves” have something in common—growing earnings.  The “have-nots” also have one similarity—slower growing or contracting earnings.  Below we have presented two Technology stocks, Microsoft and Canada’s CGI, that shows their earnings growth (orange line) and share price (purple line).   Over the past five years, Microsoft’s earnings have grown

113% and the share price is up 234%.  CGI’s earnings have grown 56% and the shares are up 32%.  Between now and 2026, CGI’s earnings are expected to grow 18% whereas Microsoft’s are forecast to increase almost twice as fast at 32%.  This difference in earnings growth rates partly explains the difference in share price gains.

We have another instance of “haves” and “have-nots” when we look at earnings forecasts for the TSX and S&P 500.  The S&P 500 is a “have” while the TSX is a “have-not”.  Although earnings are projected to grow for both, the S&P 500 growth rate is faster than the TSX.  Earnings forecasts for the S&P 500 have been revised up for the next two years with Technology and AI a major contributor.  This makes it possible to justify a higher target, 5,700, than our current 5,350, as long as the p/e multiple does not decline and earnings do not fall short.  We are maintaining our 2024 TSX target at 23,000.

When it comes to valuation, we would say the TSX is a “have-not” while the S&P 500 is a “have”.  The p/e multiple for the S&P 500 (price divided by estimated earnings) is 20.4 which is higher than the historical average.  The p/e multiple for the TSX is below average at 13.6.  In part, this reflects the higher variability of commodity earnings and limited exposure to AI.  We believe TSX stocks are being overly penalized for a lower growth rate.

Risks (upside and downside) to our forecast include:

Artificial Intelligence -Disappointing results from influential stocks such as NVIDIA could cause p/e multiples in the Technology sector to deflate.  Because Technology makes up about 30% of the S&P 500, a reduction in valuation would have a negative impact on the overall index.    

Economy - It has held up much better than expected to higher interest rates.  Normally, rising interest rates have a lagged negative impact on economic activity.   We are seeing slower growth but it remains positive.  The probability of a recession in 2024 is considered low by many investors.  Should a recession occur, stock prices would likely decline due to both lower earnings and falling p/e multiples.  On the other hand, continued strength in the economy will support earnings and stocks.

Inflation – This is a key factor influencing rate cuts.  Inflation has been declining however, it remains above the central banks’ 2% inflation target.  Higher wages and increased costs for services like restaurants, housing/rent, and air travel are boosting inflation while lower goods prices are causing disinflation in some categories.   Lack of progress in getting inflation down could cause bond yields to rise and delay rate cuts even more.  Eventually, this could put downward pressure on stocks

U.S. election – The outcome is too close to call.  Should Trump win, his election agenda could provide a short term boost to the economy and stock market if he cuts taxes.  On the other hand, raising tariffs would hurt economic growth and damage confidence worldwide.

Supply Chain Disruptions - The wars in Ukraine and Gaza have impacted trade and supply chains.  This has put upward pressure on inflation.  Continued attacks in the Red Sea have caused an increase in shipping costs due to higher insurance rates and longer shipping times.  The risk of a wider Middle East war that could affect oil production and transportation would also be inflationary.

The performance of stocks in 2024 has been lopsided with both “haves” and “have-nots”.   So far, the S&P 500, Technology/AI and Mining are among the “haves”.  The TSX, Canadian Communications and Real Estate are have-nots.     For the remainder of this year, we could see the S&P 500 continue to outperform however, over a two year time frame, we expect similar returns from the TSX and S&P 500.  The edge the S&P 500 has on growth is counterbalanced by the low valuation for the TSX.