The Week in Review

Weekly Market Recap: U.S. and Canada

The thrill of victory and the agony of defeat. Canadians saw a lot of red this week, both while cheering on our Olympic athletes in Paris and while watching as stocks took Olympic-sized dives.

Weak labor market data and uneven earnings weighed on stocks and we saw declines across the board.

Hardest hit was the Nasdaq, down more than 3% on the week. This now puts the tech-heavy index in a correction, down 10% from its July 10 record. Not far behind, the TSX dropped 2.50%, the Dow snapped a four-week string of gains, and the S&P 500 was down 2.06%, leaving it 5.7% below the record high that it achieved in mid-July.

S&P 500 Returns | Week At-a-Glance

TSX Returns | Week At-a-Glance

Major Economic Stories This Week

Canada GDP Growth Slows to 0.1% in June

Canada's GDP is projected to grow by a modest 0.1% in June. This growth is lead by increases in construction, real estate, rental & leasing, and finance & insurance sectors. These gains are partially offset by declines in manufacturing and wholesale trade.

• May 2024 GDP growth: 0.2% (above expectations)

• Goods-producing industries growth: 0.4%

• Services-producing industries growth: 0.1%

• Notable sectoral gains: finance & insurance (+0.2%), public administration (+0.4%), educational services (+0.5%)

US Job Growth Slows in July

The US economy added only 114,000 jobs in July, coming in short of the forecasted 175,000 and marking the lowest level in three months. This is a significant slowdown from the downwardly revised 179,000 jobs added in June, indicating a cooling labor market. Key sectors with employment gains include healthcare, construction, and transportation.

• Jobs added in July 2024: 114K (below expectations)

• Previous month revised jobs: 179K

• Healthcare sector jobs: +55K

• Government sector jobs: +17K

US Unemployment Rate Rises to 4.3%

The US unemployment rate increased to 4.3% in July, up from 4.1% in June and higher than market expectations. This is now the highest unemployment rate since October 2021. Even with the increase, the labor force participation rate edged slightly higher to 62.7%.

• July 2024 unemployment rate: 4.3%

• Previous month unemployment rate: 4.1%

• Market expectation: 4.1%

US ISM Manufacturing PMI Falls to 46.6

The ISM Manufacturing PMI dropped to 46.6 in July, from 48.5 in June, indicating a sharper contraction in US factory activity. This is the steepest decline since November 2023 and reflects the ongoing impact of high interest rates on demand for goods. New orders and employment levels also saw significant drops.

• July 2024 ISM Manufacturing PMI: 46.6

• June 2024 ISM Manufacturing PMI: 48.5

• New orders index: 47.4

• Employment index: 43.4

Key Takeaways From this Week’s Economic News

Canada GDP Growth

The modest GDP growth of 0.1% in June 2024 highlights the mixed performance across different sectors of the Canadian economy. The slight expansion is largely due to gains in construction, real estate, and finance & insurance sectors, indicating resilience in these areas. However, the decline in manufacturing and wholesale trade signals potential underlying weaknesses that could affect future economic stability.

US Job Growth Slowdown

The big slowdown in US job growth to 114,000 in July is a clear indicator of a cooling labor market. This slowdown, particularly when job gains are well below the average monthly increase over the past year, suggests that economic growth may be losing momentum. It also highlights potential challenges ahead, such as reduced consumer spending and potential impacts on economic growth. Policymakers might need to consider additional measures to stimulate job creation and support the labor market.

US Unemployment Rate Increase

The rise in the US unemployment rate to 4.3% in July, the highest since October 2021, signals increasing challenges in the labor market. When you couple this with a slight rise in labor force participation, it shows that more people are looking for jobs but are unable to find employment. This could indicate underlying issues in the economy, such as mismatches between skills and job opportunities, or broader economic slowdowns.

THIS WEEK’S POLL QUESTION
(Results in Next Week’s Newsletter)

THE MARKETS
Nasdaq 100 Correction Amidst AI Stock Slump

Key Points:

• Nasdaq 100 Index enters correction territory, losing over $2 trillion in value.

• Significant declines in major tech stocks like Nvidia, Tesla, Microsoft, and Amazon.

• Market shift towards defensive sectors amid red flags in tech valuations.

• Volatility spikes in Nasdaq 100, Apple, and Amazon.

Nasdaq 100 Index Drops into Correction Territory

The Nasdaq 100 Index has taken a sharp turn and has quickly dropped into correction territory, shedding more than $2 trillion in value within just three weeks as traders move away from Big Tech investments. The index fell by 2.4% on Friday, marking a loss of over 10% since its peak on July 10, though it still remains nearly 10% up for the year.

Several major tech stocks have taken significant hits. Nvidia Corp. and Tesla Inc. have each dropped more than 20% from their recent highs, placing them in bear-market territory. Microsoft Corp. and Amazon.com Inc. have both lost over 10%, although most big tech stocks, excluding Tesla, are still up for the year.

Investment Experts Weigh In

Bill Stone, chief investment officer at Glenview Trust Co., commented on the abrupt shift, likening it to "crashing into a brick wall." He noted that the rapid rise in tech stocks could not be sustained indefinitely, emphasizing the need for diversified investments beyond just tech.

For the record, I fully agree with him on this point. In this newsletter, on our YouTube channel and in our Investing Academy, we are always preaching balance. Sometimes this can sound like a broken record, especially when the markets are moving straight up, but at some point it makes sense. We may be at one of those points right now.

Notable Decliners in Tech

Among the biggest decliners were Amazon and Intel Corp. Amazon's shares fell 8.8% on Friday due to heavy AI spending plans, while Intel saw a 26% drop following a dismal forecast, marking its largest one-day percentage decline since 1982.

Concerns Over High Valuations and AI Spending

Warnings about the high valuations of tech stocks and concerns that AI-driven gains might be overdone have been prevalent throughout the year. (They have also largely been ignored.) Now that we see high-profile earnings falling short of expectations, investors are now shifting their focus to more defensive sectors. Utilities, for example, have been leading the market in recent sessions, with Treasury yields falling as traders anticipate the Federal Reserve might cut interest rates in September.

Rising Volatility

The Cboe NDX Volatility Index, which measures 30-day implied swings in the Nasdaq 100, briefly spiked above 28, its highest level since March 2023. Volatility indexes for Apple and Amazon have also increased, and the Cboe Volatility Index (VIX) is at its highest in over a year.

Impact of Alphabet's Capital Expenditures

The downturn in the tech sector intensified after Alphabet Inc. reported capital expenditures exceeding estimates by $1 billion, mainly due to AI investments. This has prompted investor concern over significant spending with uncertain short-term revenue prospects, leading to a broader tech selloff. Microsoft and Amazon also indicated heavy AI spending in their earnings reports. For those of you old enough to remember, do you hear any rhymes from the Tech Wreck? Think Cisco, perhaps?

A Shining Light

But not everything was down on Friday. Apple Inc. saw a 0.7% increase on Friday following a positive earnings report, and Meta Platforms Inc. saw gains earlier in the week after its own earnings announcement. Even the Mag 7 are doing their own thing.

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THE ECONOMY
Bank of Canada Now Expected to Cut Rates Amid Weak U.S. Jobs Data

Key Takeaways:

• Bank of Canada expected to cut rates at each remaining meeting in 2024

• Weak U.S. job market influencing Canadian policy

• Canadian bond yields falling

• Potential rebound in Canadian housing market

Market Reactions to U.S. Jobs Data

Markets are anticipating that the Bank of Canada will cut interest rates at each of its remaining decisions this year following unexpectedly weak U.S. job data. The U.S. unemployment rate rose to 4.3%, leading analysts, including those at Citigroup and JP Morgan, to predict significant rate cuts from the Federal Reserve.

Policy Independence and Economic Interdependence

Governor Tiff Macklem maintains that the Bank of Canada sets its policy independently, but the close economic ties between the U.S. and Canada mean that Canadian policy will likely follow suit. Benjamin Reitzes of the Bank of Montreal says:

Canadian Bond Yields and Rate Cut Expectations

Canadian bond yields fell sharply after the U.S. data release Friday, with yields on five-year notes dropping to their lowest level since May 2023. Traders are now fully pricing in three more rate cuts this year, reflecting expectations that the central bank will ease at each of its upcoming meetings. Doug Porter of the Bank of Montreal forecasts that the policy rate will drop from 4.5% to 3.5% by January and to 3% by mid-2025, arriving at the expected endpoint earlier than previously anticipated.

Early Rate Cuts and Currency Concerns

In June, the Bank of Canada was the first among the Group of Seven countries to begin easing rates, cutting them again in July amid signs of cooling inflation. Macklem’s early cuts sparked concerns about currency stability due to diverging policies with the Fed. However, those concerns are diminishing as U.S. and Canadian outlooks realign. Taylor Schleich of National Bank of Canada said:

Inflation Risks and Housing Market Rebound

The global bond rally could also reignite risks of inflation in Canada. Most Canadian fixed mortgages have terms of five years or less, and falling yields could lower these rates, potentially causing a rebound in the housing market. The Bank of Canada previously downplayed the risk of surging home prices complicating inflation control.

TECHNOLOGY
Will AI Investments Ever Pay Off?

Key Takeaways:

• Tech giants face pressure to show returns on AI investments.

• Significant spending on AI infrastructure with little immediate revenue.

• Investor concerns grow over the profitability and timelines.

• Tech leaders emphasize long-term vision over short-term gains.

AI Investment Concerns

As we saw in our lead story this week, tech stocks appear to be correcting. Wall Street's tech earnings season has brought a pressing question to the forefront: when will investments in artificial intelligence (AI) begin to yield profits? Over the past 18 months, since the launch of ChatGPT, tech companies have invested billions in data centers and semiconductors to support large AI models, promising revolutionary changes across industries. However, the practical applications rolled out thus far—such as chatbots, AI coding, and AI-enabled search—seem trivial and lack clear paths to monetization.

Investor Reactions

Amazon's recent earnings report highlighted investor concerns over the company's heavy spending on AI without significant returns. Similarly, Intel's shares collapsed following its announcement of cost-cutting measures and layoffs, despite substantial AI-related expenditures. This situation raises a fundamental question: is the massive investment in AI justified?

Analyst Perspectives

Morgan Stanley analyst Keith Weiss spoke about the industry debate on Microsoft's earnings call, and he questioned whether the capital expenditures on generative AI will be matched by monetization.

Weiss was joined by UBS analyst Steven Ju, who asked Google CEO Sundar Pichai about the timeline for AI to generate revenue and create value beyond cost savings. He asked:

A Goldman Sachs report also echoed these concerns, suggesting there might be "too much spend, too little benefit" in AI investments.

Tech Firms' Long-Term Vision

Ok, so there’s not shortage of this type of concern, but that’s not necessarily stopping major tech firms like Google, Microsoft, and Meta, which have all signaled plans to increase their AI-related spending. Meta's CFO Susan Li noted that returns from generative AI are expected over a longer period, not significantly impacting revenue in 2024 but potentially opening new revenue streams in the future. Microsoft's CFO Amy Hood also projected that their data center investments would support AI monetization over the next 15 years and beyond.

Investor Expectations vs. Reality

But there’s something missing here. This long-term perspective contrasts sharply with investor expectations for quicker returns. D.A. Davidson analyst Gil Luria highlighted the discomfort investors feel with the extended timelines for AI profitability, likening it more to venture investment than typical public company returns. As a retired advisor, I’m keenly aware of the disconnect between someone having a theoretical ‘long-term outlook’ and the actual reality of investing, which tends to be measured on a much shorter timeframe.

Tech CEOs' Stance on AI Investment

Tech CEOs remain united in their belief that underinvesting in AI poses a greater risk than overinvesting. As Google’s Pichai stated, the goal is to avoid missing out on AI leadership due to inadequate computing capacity. (Corporate FOMO maybe?) Nevertheless, Luria predicts that by late this year or early next, investor pressure may force tech companies to scale back their AI infrastructure investments, emphasizing the unsustainable nature of current spending levels.

HOUSING CRISIS
New Mortgage Rules: Will They Help?

Key Takeaways:

• New 30-year amortization for first-time buyers

• Applies only to newly built homes

• Mixed reactions from experts

• Limited impact on high-priced markets

Overview of New Mortgage Rules

New mortgage rules from the federal government that took effect this week won't "move the needle," according to some experts. Starting August 1, first-time homebuyers have 30 years to pay off their insured mortgage, required when a down payment is less than 20% of the home price. This policy only applies to newly built homes.

Expert Opinions

Frank Napolitano of Mortgage Brokers Ottawa isn’t overly optimistic that this will provide much needed support.

He adds that while a 30-year amortization could lower monthly payments by $250 on a $500,000 mortgage, it isn’t significant enough, especially with elevated interest rates and challenges in saving for a down payment. For many young Canadians, this minor reduction in monthly payments might not be sufficient to overcome the hurdles of high property prices and stringent mortgage qualifications.

Government's Perspective

Finance Minister Chrystia Freeland described the measure as part of a broader effort to help younger Canadians afford homes.

The intention is to make homeownership more accessible, but the limited scope may not bring substantial relief to all prospective buyers.

Market Impact and First-Time Buyers

Only 17% of mortgages in Canada were insured in late 2023, and first-time buyers made up less than half of home purchases in early 2024. The federal government defines a first-time homebuyer as someone who has never purchased a home, hasn't owned their principal residence for the last four years, or has experienced a marital breakdown.

Challenges and Limitations

Robert Hogue, assistant chief economist for RBC, points out potential drawbacks:

He also notes that the rule won't apply to homes over $1 million, limiting its impact in expensive markets like Toronto and Vancouver. However, he believes it will help increase housing supply.

Additional Government Measures

In addition to the amortization change, the government has increased RRSP withdrawal limits and launched the First Home Savings Account, aiming to build nearly four million homes by 2031. These measures combined are designed to support Canadians in achieving homeownership, although their overall effectiveness will depend on implementation and market conditions.

COMMUNICATIONS
Telus International's Earnings Cut & CEO Shuffle

Key Takeaways:

• Telus International slashes earnings forecast.

• CEO Jeff Puritt to retire, replaced by Jason Macdonnell.

• Revenue hit by competition and reduced spending from Meta Platforms Inc.

• Company rebranding as Telus Digital Experience.

Leadership Shakeup

Telus International Inc. has slashed its earnings forecast and announced a major leadership shakeup. CEO Jeff Puritt will step down after 16 years, with Jason Macdonnell set to replace him. This announcement coincided with the company’s shares plummeting 36% to an all-time low.

Earnings Forecast Reduction

The Vancouver-based digital services provider, controlled by Telus Corp., cited intense industry competition and a slowdown in new customer bookings as key reasons for slashing profit guidance for the year by more than half. A decline in spending from Meta Platforms Inc. also impacted revenue and profit margins. Puritt stated:

Revised Projections

The company now projects full-year revenue between $2.61 billion and $2.67 billion, down from $2.79 billion to $2.85 billion. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) are expected to be between $465 million and $485 million, a sharp decrease from the previous range of $623 million to $643 million. Adjusted earnings per share have also been revised downward to $0.39 to $0.44 from the previous $0.93 to $0.98.

Revenue Diversification and Challenges

Despite diversified and growing revenue from Google LLC and Telus Corp., which constituted about 39% of Telus International's revenue in the first half of the year, it wasn’t enough to offset other business pressures. The company highlighted that customer expectations for better services at lower costs, spurred by the macroeconomic environment over the past 18 months, are likely to persist. Puritt emphasized the competitive landscape:

Realistic Outlook and Leadership Changes

Senior leadership expressed a more realistic outlook for the remainder of 2024. (Hey, shouldn’t outlooks always be ‘realistic’? But I digress.)
Expectations are that margins will stabilize and only half of the previously planned $60 million in cost savings will be realized.
In addition to the CEO stepping down, leadership changes also include the departure of COO Jose-Luis Garcia and CFO Vanessa Kanu, replaced by Gopi Chande.

Rebranding and Future Strategy

Telus International, which went public in 2021, is now rebranding as Telus Digital Experience.

Market Movers

Top 10 Weekly Gainers

Top 10 Weekly Losers

10 Most Overbought Stocks

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The Relative Strength Indicator (RSI) can provide a signal that suggest a stock is either overbought or oversold.
📈A stock that has an RSI over 70 is considered to be in “overbought” territory. This might suggest that the stock is due for a pullback, however it is not a recommendation to sell.
📉A stock that is trading with an RSI below 30 is considered to be in “oversold” territory. This might suggest that the stock is due for a recovery, however it is not a recommendation to buy. Always perform your own due diligence.

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