Market Compass video series

Hello everyone, and welcome to the first edition of the Market Compass! In today's episode, we'll discuss a theme that we highlighted in our 2024 Annual Outlook: The broadening of market leadership. We know that stock market returns in 2023 were very narrow – led primarily by U.S. mega-cap technology and a handful of U.S. companies known as the Magnificent Seven. So nearly three months into 2024, where do we stand now? Markets have certainly moved higher, with the S&P 500 up nearly 8% this year and the TSX up about 4% as of mid-March, but has market leadership expanded beyond the Mag 7? And how does the Mag 7 impact Canadian investors? And if leadership is broadened, how are the Canadian equity markets impacted? We'll go through this and more in today's episode, which can be found on EdwardJones.ca.

2024 thus far, starting to see some broadening of participation:

In 2023, we know that stock markets were led by a pretty narrow group of U.S. stocks and sectors, primarily in the mega-cap technology space, driven by the growing enthusiasm around artificial intelligence and generative AI broadly. However, this year we are seeing overall a broader group of sectors and asset classes that are outperforming. Let's take a look first at the S&P 500 sector returns.

Last year if you recall, U.S. sector returns were led by three sectors – technology, communication services, and consumer discretionary – all up by over 40% for the year. An important note is that while Canada also has the same sectors – the returns and make up of these sectors are not comparable. For example, the communications sector in the U.S. includes Meta and Alphabet, which are two of the Magnificent Seven, whereas the Communications sector in Canada consists of mainly Canadian telecom stocks, which are defensive and significantly lagged last year. The weights of sectors also contributed to the TSX underperformance. These top 3 U.S. sectors in 2023 made up almost 50% of the S&P 500, whereas they only accounted for roughly 15% in the TSX.

That doesn't mean that Canadians can't achieve gains based on U.S. sector performance because many Canadians hold US equities including those in the Magnificent 7. And this is why regional diversification is so important. What are we seeing this year? Indeed, we are seeing broader sector leadership. Areas like energy, and financials are up over 7% thus far in the U.S., and energy and industrials are up close to 10% in Canada.

And similarly, if we look at asset classes more broadly, as well as the Magnificent 7 cohort, we can see that while technology continues to lead in 2024, we are seeing some notable catch-up in the broader S&P Equal Weight index, the TSX in Canada, and the high-quality S&P dividend payers, as well as parts of international markets. And although bond markets remain slightly negative this year in both Canada and internationally, we could see this asset class perform better if interest rates move lower later this year.

What do we need to see for this to continue?

So, what conditions would we need to see for this broadening of market leadership to continue in the year ahead? I'll highlight three that we see as important precursors for this trend to continue.

First, we expect to see the central banks like the Bank of Canada and the Federal Reserve embark on a rate-cutting cycle this year. The inflation rates in Canada and the U.S. are nearing the target rate that the central banks need to see to begin to cut interest rates – albeit not in a straight line. We believe that 2-3 rate cuts in Canada and the U.S. are likely later in 2024, perhaps starting in the summer. Keep in mind that as interest rates move lower, the economy and consumption is supported, and stock market valuations have scope to expand, which we think is an important driver for better performance in cyclical and value parts of the market.

Next, we believe earnings growth should materialize this year across many sectors in 2024. Last year S&P 500 earnings growth was modest, up about 1%, and the biggest drivers of growth were in technology as well as communication services and consumer discretionary. This year, we see S&P 500 earnings growth higher, in the 10% range, driven by a broader group of sectors. Areas like health care, financials, industrials and even utilities are expected to contribute to growth, alongside technology and other growth sectors. So, we see a broadening in earnings growth also as a driver in the broadening of market leadership.

And finally, while the Canadian economy may continue to be soft in the first half of the year, we expect it to re-accelerate in the second half. The Canadian economy avoided a recession in 2023, in the face of rising interest rates with GDP growth of just over 1%. We would acknowledge that elevated household debt levels in Canada and higher interest rates have pressured household spending over the past year. However, lower inflation and potential interest rate cuts from the Bank of Canada could pave the way for a rebound in economic growth later in 2024. This is a backdrop which we believe favours a broadening of leadership, particularly in areas like cyclical and interest sensitive sectors, and small- and mid-cap stocks.

Market volatility and concentration of returns remind us of the importance of diversification.

Overall, equity market leaders are broadening. However, this year, like in any given year, we expect bouts of volatility to emerge. In fact, two to three pullbacks in the 5-10% range are the historical norm.

This makes the case for a well-diversified portfolio – that includes diversification across sectors, regions, and investment-types. As always, your portfolio should be positioned to reflect your risk tolerance and risk capacity and should be set up to help you meet your personal financial goals.

Speak with your advisor and let them know if anything in your life has changed. A life event like a new job, a move, a change in marital status, a new addition to the family or the loss of a loved one may impact your financial goals, including the timing of those goals, and the level of risk you're comfortable with to achieve them. Like a compass, your Edward Jones advisor will help you navigate life's journey and better position you to achieve all of your financial goals and priorities.

Thank you for joining us today and we look forward to seeing you for our next Market Compass in June.