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Q2 2023 Market Commentary


2023-07-07, Mathew Hermary

Equities rallied in the second quarter as resilient economic data had investors thinking less about recession and more about the end of the Fed’s hiking cycle. The S&P 500 technically entered a bull market, up more than 20% from its October lows. Meanwhile, the Nasdaq had its strongest first-half performance in 40 years, rising 32%.

Approximately 80% of the S&P’s 16.9% year-to-date return has been driven by just 10 companies while the percentage of stocks outperforming the S&P 500 over the past 3 months fell to just 11% during the quarter, less than the previous March 2000 low of 20%, in what was one of the narrowest markets in history. The less tech heavy TSX rose just 5.7% since January.

After rising interest rates and inflation defused excessive tech valuations in 2022, excitement surrounding the potential of artificial intelligence (AI) has rapidly reignited market sentiment for businesses expected to benefit from this nascent megatrend.

Source: Datastream, SG Cross Asset Research/ Equity Strategy

While AI will create meaningful long-term growth opportunities both for leaders in the space and productivity gains broadly across the real economy, many of these developments remain relatively distant promises. In the meantime, AI likely lies somewhere in the initial arc of a classic technology hype cycle.

Source: Gartner Inc.

QV’s equity strategies generated stable, positive returns during the quarter, with returns ranging between 3.2-7.3% year-to-date. The bond and income strategies were broadly flat in the quarter and up 2.1% and 1.7% so far this year.


The economy and the consumer remained buoyant in the second quarter. First quarter US GDP was meaningfully revised up to 2% in June from initial 1.3% estimates. Strong US payroll data showed that 339,000 new jobs were created in May, even as the unemployment rate began to edge upwards to 3.7% from the prior +50-year lows of 3.4%. Retail sales also continued to grow, rising 0.3% month over month in May. Many economists have responded to this data by retrenching from previous calls for a looming recession. And yet, numerous indicators suggest that the economy remains in a late stage of expansion. The yield curve remains heavily inverted; bank credit is tightening; manufacturing surveys suggest contraction within the industrial economy; and temporary hiring, often a precursor to broader hiring trends, is in decline.

Economies are complex, adaptive machines and forecasting short-term outcomes provides a blurry view of an uncertain outcome at best. Distortions from COVID era policies are still reverberating through global economies, adding additional static to the signals. Rather than attempt to forecast the economy, investors should instead consider what outcomes asset prices reflect and where the balance of risk lies. At current valuations, many areas of the stock market appear to be extrapolating the recent strength of the economy well into the future. We think the opportunity lies in the areas where valuations already reflect a potentially weaker outlook.


Following one of the most severe tightening cycles in history, central bank policies have begun to diverge.

After pausing at its March and April meetings, the Bank of Canada pivoted and increased its benchmark rate to 4.75% in June in reaction to strong consumer spending amidst continued inflation concerns. The Federal Reserve paused for the first time in June but at least two more increases are expected in the second half. Across the Atlantic, the European Central Bank raised its main refinancing rate to 4.0% and asserted they have no intention of pausing. In contrast, the Chinese are now cutting rates in response to a weak recovery following a re-opening from COVID lockdowns.

As central bank policies begin to diverge, currencies, economies and regional markets seem likely to as well. This plots a nonlinear trajectory for the global economy and potentially creates a more challenging backdrop for the Federal Reserve to contain inflation in future quarters.


Inflation continued to decline in May, falling to 4% in the US and 3.4% in Canada, while core inflation remained higher at 5% and ~4% respectively. Given the declining trend, many market commentators are now proclaiming that inflation is all but vanquished. Shipping costs and commodity prices have plummeted since 2022 and the M2 money supply is now contracting for the first time in data going back 60 years. In the 1970’s, investors cheered falling inflation with rising stock prices and so far in 2023, the script appears to be repeating.

Source: Federal Reserve Bank of St. Louis

While inflation should drift lower in the near-term, have the forces of inflation truly been conquered?

Surges in inflation have historically been accompanied by commodity price shocks. Little has been done to address underinvestment in supply in recent years and geopolitical instability remains an ever-present risk to price stability. After decades of disinflationary benefit from the hollowing out of American manufacturing, the gears of globalization have begun to reverse as companies look to onshore production in a less stable world. At the margin, onshoring is inflationary. Finally, labour markets remain very tight and wage growth has remained persistent. The longer this remains the case, the more entrenched inflation could ultimately become.

If inflation is not dead but instead retreating into temporary dormancy, how is the Fed likely to respond if inflation either remains above target or even begins to re-accelerate in 12-18 months? The Fed’s credibility is already at stake in a way it hasn’t been in decades. Both bond and equity markets are convinced the Fed will lower rates sooner than they have signalled. What are the implications if markets are wrong about the Fed’s conviction either to fight inflation or its ability to lower rates as expected if inflation begins to rise again at some point?

Two years ago, most professional investors would have said with high certainty that central banks would not bring policy rates to 5% and that the economy could never sustain those levels even if it did. Today, inflation expectations for the next five years remain grounded at ~2.2%. In other words, the market still expects inflation to revert to long-term averages in the future. While this is certainly possible, we wouldn’t want to own a portfolio that only makes sense if the consensus view proves to be correct.

Managing risk means being able to generate reasonable outcomes in a variety of environments. We think a future where inflation is more persistent than current expectations suggest is still a scenario worth contemplating.


There’s an old Wallstreet adage, “Don’t fight the Fed”. It means investors shouldn’t bet against the direction of monetary policy or the Fed’s resolve to slow down or speed up the economy and by extension, to impact asset prices. So far in 2023, investors have successfully fought the Fed as equity markets have rallied in the face of tightening monetary policy.

Historical precedent shows it’s not unusual for stocks to rise during central bank hiking cycles or even to rise temporarily after the Fed pauses. But the higher rates go and the longer they stay high, the more gravity the saying typically holds.

There is no rule which says the future will unfold like the past, but when investors are stretching for return in risky securities as the Fed is draining liquidity from financial markets, they run the risk of discovering it may not be too dissimilar to picking up pennies in front of a steamroller. We believe prudence and margin of safety remain effective prescriptions amidst the uncertainty of Fed tightening.


Luckily, long-term investors don’t have to make a binary choice between owning a seemingly expensive stock market or sitting on the sidelines in concern over a looming recession that may not even come.

The reason is that the current ‘market’ is about as far from a monolithic construct as it has been in decades. When we look beyond highly valued mega-caps that have been driving global stock returns in 2023, there is a diverse array of opportunity. There are industries that have already experienced rolling recessions, and attractive valuation multiples in boring businesses that are far from the limelight. For value-conscious investors, this offers a uniquely attractive alternative.

The wide distribution of opportunity is captured well in the below chart. While the P/E of the median stock in the S&P 500 (represented by the green line in the chart below) is at an unexceptional level relative to history, the width of the grey channel highlights an extreme between the valuations of low P/E stocks and high P/E stocks.

Source: Compustat, FactSet, Standard & Poor’s, J.P. Morgan Asset Management

High P/E stocks, as represented by the 80th percentile of stocks in the S&P 500, trade at >27x P/E currently, while the 20th percentile of S&P 500 stocks trade at just ~11x earnings. Historically the spread between the two contingents has averaged 11.7x. Today it is 17.3x. Very rarely have low P/E stocks been so cheap relative to high P/E stocks. For value conscious investors, we think this highlights an unusually attractive opportunity set.


Our strategies remain diversified by sector and economic sensitivity. We continue to expect reasonable outcomes under a variety of economic conditions. Canadian, international, and small cap stocks have been unloved areas of the global marketplace over the prior decade, and both look historically cheap relative to the US market. We believe this will be a tailwind in coming years.

Valuations in our strategies are reasonable. We continue to prefer equity financed balance sheets that can contend with higher interest rates and businesses that continue to grow their earnings over time. These factors offer a potent formula to get on base consistently. Our equities remain complemented by our fixed income strategy which owns high-quality credits offering competitive yields. In contrast, numerous areas of the market reflect extreme valuations, high expectations, and broad-based speculation.

In the current market, many investors appear to be swinging too hard for the fences. Given the uncertainty of outcomes for the economy and inflation, we think staying focused on pitches we know we can hit and getting on base consistently looks increasingly like a winning strategy.


As a reminder, we recently launched the QV Money Market Fund. In an environment where banks continue to pay very little on your savings, QV’s Money Market Fund provides a secure and reliable way to generate income on your savings and surplus funds. To learn more, please see here or get in touch with your investment counsellor.

All views and projections are the expressed opinion of QV Investors Inc. and are subject to change without notice. This Update is provided for informational purposes only. QV Investors takes no legal responsibility from any losses resulting from investment decisions based on the content of this Update.


Mathew Hermary | Chief Investment Officer

Mathew oversees QV’s investment strategies and makes portfolio decisions for the global equity strategy.