Sid Mokhtari is the chief market technician at CIBC Capital Markets.Supplied
Today, the U.S. 10-year Treasury yield crossed above 5 per cent for the first time since 2007. Meanwhile, the Canadian 10-year Government bond yield is approaching 4 per cent.
Rising bond yields combined with high oil prices, geopolitical tensions, tariffs and growing concerns surrounding AI development and the need for independent oversight and regulation are putting pressure on equity markets.
But there may be a catalyst on the horizon. Earnings season kicks off in a few weeks, which could provide a tailwind for equity markets. According to a Sept. 18 report by LSEG I/B/E/S, S&P 500 (INX) earnings expanded by 53 per cent in the second quarter with earnings growth of 30 per cent anticipated for the current quarter.
Analysis: As 5% U.S. Treasury yields lose shock value, investors start worrying about 6%
On Sept. 18, The Globe and Mail spoke with CIBC’s chief market technician Sid Mokhtari to get his take on where equity markets may be headed and what sectors and securities may outperform.
We are currently in a brief period of seasonal weakness. Consistent with historical trends, September is on track to deliver a negative return. Given the pullback in equity markets that we’ve seen in September, what does the technical setup look like for the fourth quarter?
We think this is a bending condition, not a breaking condition. We believe that the setup is more of a mean reversion within parts of the market that have a high weighting in the S&P 500, and I’m going to use the S&P 500 as my proxy benchmark for the directional bias.
Technology remains a significant relative outperformer when we look at the entire space collectively on an equal-weight basis, and the relative strength of technology is still showing good leadership but it’s bifurcated. In other words, investors need to be a lot more selective in their choices.
The health care sector also has a high weighting in the S&P 500, 11 per cent plus, and it is also showing good relative leadership and durability.
And then financials in the U.S., as well as in Canada, are still holding in quite well, irrespective of the fact that we’re seeing the U.S. yield curve flattening.
I’m optimistic that these three sectors, which have large weightings in the broader benchmark indices, should be able to at least cushion the downside.
We’re not seeing a big alteration in the relative strength of technology, health care, as well as financials. Generally, they have been collectively receiving flows from other GICS sectors that have been losing relative performance.
What is the narrative for the S&P/TSX Composite Index? Can you give us your outlook for it?
We think the Canadian dollar will be under pressure relative to the U.S. dollar into year-end. I believe the interest rate differential should have a weaker bias for the Canadian dollar. I think the Canadian dollar should be closer to 70 cents by year end or sometime in between.
Historically, when the Canadian dollar is weaker, equity indices in Canada tend to perform better. So, it typically tends to bring about support for the benchmark index when we look at it historically. We have a lot of resources that tend to benefit from a weaker currency.
If I had to make a call as to what level the TSX Index (TXCX) would be at year end, I think 37,800.
You spoke about leadership remaining in the technology space, albeit bifurcated. So, do you expect to see growth and momentum factors strong in the fourth quarter?
Factors that are performing better are still associated with value, quality and, in part, dividend yield.
Growth and low volatility are still in the weaker part of the lagging quad.
Earlier you said leadership from a relative strength perspective is from technology. So why isn’t the growth factor showing up positively? Why is it so weak?
Semiconductors are the growth and cyclical part of technology, and that’s one area that is causing the growth factor to come down.
Also, not all tech names are growth. When we look at large-cap tech, we find a lot of quality stocks such as Apple Inc. (AAPL-Q) and Microsoft Corp. (MSFT-Q), which have large weights in the benchmark and their performance has been relatively strong against the rest of the tech sector. So, we can still select some of the software names in the U.S., as well as the likes of Apple, which are considered to be value as well as quality.
Staying on the technology discussion, I noticed in your sector matrix Taiwan ETFs with high technology exposure, iShares MSCI Taiwan ETF (EWT-A) and Franklin FTSE Taiwan ETF (FLTW-A), are ranked number two and three.
I do think that’s where attention is. That’s where the money is flowing from a global regional ETF perspective.
Japan is also showing quite well. The Far East ex China does get a lot of positive flows.
Emerging markets are also acting well.
We’re dealing with a market that is still very bullish when you look at things globally.
I think it’s important to have a diversification approach by being invested in other parts of the world.
You publish a monthly report with your top 10 stock ideas. Your portfolio of top picks for September has a significant weighting in energy, representing a 30 per cent exposure. We’ve seen the price of WTI crude oil surge above US$100 a barrel before falling back. On September 9, you published a research note saying that WTI was headed to US$105, which it rallied to a few days later – it was a great call. What do you believe is the path forward for the price of oil?
I think we are likely to stay above US$90 for a while. We have seen a big shift in technical indicators that support WTI remaining above US$90. We should be able to consolidate above US$90 and then maybe it will try to rally again. In the near term, we have seen a measured move being completed.
But we don’t have a lot of divergences to suggest that the strength in WTI or the energy sector is subsiding. Over 70 per cent of the members of the TSX energy sector, as well as the U.S. energy sector, are trending above all averages. Relative strength lines are showing quite well. Money flow readings are showing quite well. So, this is still a very good sector.
I also want to say that natural gas is not doing that great as a commodity, but when you look at an ETF called First Trust Natural Gas ETF (FCG-A), it looks quite constructive.
Within our top 10 ideas for September, we included Kelt Exploration Ltd. (KEL-T), a natural gas stock that looks quite well in our model, scores well fundamentally and quantitatively.
In your sector ETF matrix, the top four names were all energy-related ETFs: State Street SPDR S&P Oil & Gas Exploration and Production ETF (XOP-A), Invesco S&P 500 Equal Weight Energy ETF (RSPG-A), State Street Energy Select Sector SPDR ETF (XLE-A) and iShares Global Energy ETF (IXC-A). So, you don’t believe that’s marking a peak or selling opportunity? You believe this leadership in energy can persist, at least in the near term?
I’m not seeing any negative divergences or a negative delta in our matrix factors to suggest it’s a peak. Breadth is still quite strong within this space.
And as we enter the colder part of the year, natural gas should be able to come back into play again.
So, I’m constructively biased for the energy sector.
Another commodity that is surging is copper with the price trading near record highs. Your portfolio for September holds a copper stock – Teck Resources Ltd. (TECK-B-T). Where do you see the price of copper and copper stocks headed?
Copper stocks have not matched the price of copper itself.
Stocks have had their own issues. When we talk to our fundamental desk as to why copper stocks are not performing as well, there are mine issues and funding issues, for instance.
But the underlying commodity is quite strong. I think US$7 plus for copper is a technical objective. And to me, it’s the trend that matters more than levels, and the dominant trend of copper is still very supportive. I think dips within the base metals space are buying opportunities.
You publish a monthly commodities report. What current trends are you seeing?
Zinc is a good commodity, it is part of the base metals argument along with copper.
We are seeing cotton and corn show better in our improving quads.
We’ve lost some relative performance within gold and silver. For gold, US$3,800, US$4,000 are pretty good lows technically speaking. Those are longer-term Bollinger Bands that are reaching longer-term averages. And when you overlap them, historically, they tend to offer good support, and we saw that with the recent sell-off. I think we’re rebuilding a base for this space.
Seasonally, the best time for gold and silver tends to develop in the latter part of the year, late in the fourth quarter.
I think we may see more ebbs and flows between now and year end. I think any dip back to US$4,000 or slightly under is a great opportunity for this space.
I think this is a commodity cycle by some measure, and if that’s the case, I’m willing to give the gold commodity the benefit of the doubt that the trend that became parabolic may take some time to rebuild itself but it’s still durable.
We’ve seen escalating concerns surrounding AI innovation. As a result, have you seen a shift in strength to certain areas?
A lot of cybersecurity stocks in the U.S. are doing relatively quite well. A lot of them got hit with the software drawdown that we had.
We’ve seen Palo Alto Networks Inc. (PANW-Q) and Fortinet Inc. (FTNT-Q) doing relatively quite well.
But I also want to say if we were to look at AI stocks, for instance, either Nvidia Corp. (NVDA-Q) or Broadcom Inc. (AVGO-Q), it’s difficult to say that Broadcom or Nvidia are breaking down. They are in more of a pause and hold period. They’re really not doing anything from a de-trending perspective. They’re just pausing, slowing within the previous growth trajectory of trend - they’re just consolidating.
What’s the key takeaway that you want readers to come away with after reading this Q&A?
In the short term, it’s very important to recognize that as rates go higher, liquidity gets tighter. And I do think we are in a regime that has changed. We are now talking about a Federal Reserve that raised the target range for the federal funds rate and they have more of a hawkish tone. If that’s the case, then we’re talking about a rate hike cycle.
We went back and looked at rate hike cycles and if we can map this to historical rate hike cycle observations, then we have to think that there will be multiple hikes coming through. Historically, the first rate hike often gets priced in, and that’s something that we saw. But going forward, this is a late cycle transitioning environment that tends to bring about pressure and makes volatility more pronounced. So, we expect to revisit higher volatility in the next one or two months. Between now and the U.S. midterm elections, investors may want to have more dry powder and expect a potential drawdown or correction in equities before adding long-term exposure.
Also, expect the Canadian dollar to be on the weaker side. We think the Canadian dollar is going to stay on the weaker side and rally attempts are probably going to stay capped. I expect a weaker Canadian dollar, particularly as we go into the holiday season. So, I think it’s not a bad idea to get more U.S. dollar exposure.
This Q&A has been edited for clarity.