Is the Economy Headed for a “No-Landing”?

 “There are three key things going on. One is geo-political risks, which are getting elevated and causing a bit of nervousness across the board,” says Adatia, who shares lead manager duties with Jeff Elliott, managing director and head of global equities, and Marchello Holditch, managing director and head of multi-asset solutions. “The second issue is that inflation remains relatively sticky. That is causing issues regarding where we will see interest rates play out. We have already seen a forecast of six potential rate cuts at the beginning of the year, reduced to one to two rate cuts, on the Federal Reserve side of things.”

Signs of Weakness in the Labour Market

The third factor concerns the employment picture. “Although it is still strong, some signs of weakness are showing up. Whether that is in hiring intentions or even comments made by chief executive officers about their plans, or in the impact on consumers, as they potentially readjust how they spend their money,” says Adatia, a 31-year industry veteran who before joining BMO in 2021 was chief investment officer at Sun Life Global Investments and Russell Investments Canada. “I am not saying that labour signs are weak. But they are less strong than they were 12 months ago. Back then, consumers had a lot of excess savings that they had built up during the pandemic. They are now eating through those savings. Today, only the top 20% quintile still has excess savings. What you are seeing today is that more money is being spent off-debt, than off-cash. That will impact how you will spend that extra dollar going forward,” he says, adding that while job losses are not a concern yet, the job market is less attractive because there are fewer job openings than a year ago.

When it comes to markets, the worry is that if interest rates do not fall, as expected, then valuations have to adjust. “The valuations are not tied in with the current interest rate environment. You are seeing a bit more volatility and a pull-back. On top of that, you have geo-political risks as well,” says Adatia.

“No Landing” Scenario

Meanwhile, talk of recession has dissipated and more people believe there is a so-called “no landing” scenario. “That’s fine because you can still have growth, tamer inflation potentially and still get rate cuts,” observes Adatia, who works within a team of over 100 analysts and portfolio managers (of which 35 are directly involved in the fund through macro analysis and stock picking). “A hard-landing recession is pretty much priced out. Now, it’s more about the delay, and the fewer expected rate cuts. That’s what is causing the angst that you are seeing.”

As for corporate earnings, which often herald the direction in the market, Jeff Elliott, a healthcare specialist, notes that the earnings have been fairly good. “Earnings also tie in with the inflation and the interest rate story. The ability to raise prices is not as strong as it was a year ago. Some of the levers to move sales up are not what they were,” says Elliott, a 20-year industry veteran who previous worked at CI Global Asset Management. “But the earnings are still largely coming through because companies are managing their costs. What you are seeing is balancing off a lower ability to take price, and moderating growth may be moderating a little bit, and the difficulty to bring costs down for some big inputs, if inflation stays high. Everything comes back to inflation and interest rates to a certain extent. This is company-specific and as fund managers, we are looking for those companies that can balance things out to deliver results.”

Stocks Still Haven’t Had Their Interest Rate Discounts

On the negative side of the equation, Adatia is concerned about the market’s reaction should rate cuts not materialize this year. “They will have to price down these valuations. That is definitely a risk,” says Adatia. Second, he points to geo-political risks around the Ukraine-Russia and Iran-Israel conflicts. But these risks may change, depending on whether Joe Biden or Donald Trump wins the U.S. presidential election. “There are, in fact, lots of other elections this year which could change the dynamics of geo-political risks. It will affect the growth profile of many companies. There is also possibly a change in consumer spending. Will people start to tighten their belts? This could impact growth and parts of the markets. But this is an area of lower risk. The other two are higher risks.”

Thus far, BMO Global Equity F has managed to make the best of a challenging environment. In the year-to-date (April 24) the fund returned 12.48%, versus 7.30% for the Global Equity category. It has also done well over three- and five-year periods. The fund returned an annualized 9.75% and 10.37%. In contrast, the category returned an annualized 4.78% and 7.71%.

Gaining an understanding of the macro-economic picture is a vital part of managing the fund, says Adatia. “We try to understand where the opportunities will be---because in every scenario there are winners and losers---plus we need to be aware of where the risks are. This macro ‘lens’ is shared with our global sector specialists who utilize this as they gauge the best names to own, and avoid, through thorough analysis.”

Global Approach to Stock Picking

Elliott argues that the group relies on a distinctive model since seven teams of sector experts come up with names for the portfolio. “The macro view is a big input for us. We take that information and translate it to take the best opportunities within each sector. We are very reliant on the macro call,” says Elliott, who has earned an MBA from the Richard Ivey School of Business and a PhD in molecular biology and biochemistry from Simon Fraser University. Elliott notes that about 80-90% of the fund’s returns come from the individual stock picks, and the remaining 10-20% comes from the macro part of the process. Essentially, it becomes an exercise in either shaping an emphasis in one sector, versus an aversion in another. For instance, healthcare could be a big issue heading in the U.S. election. “We can be a little underweight if we need to be. This approach—great stock picking and macro calls---is why we’ve done so well in the last few years.”

Moreover, he notes that it’s not about adopting a value or growth approach. “It’s all about using the right tool for the right job. What matters to a financial services stock is not what matters to a technology stock. This year all seven of our sector teams have outperformed their sector benchmarks. The point is we want to have the right stocks in each sector in any market condition. We’re not philosophically value or growth or skewed any particular way at the portfolio level,” says Elliott. “We want to take what the market is giving us and then pick the best stocks within that framework. That’s the secret sauce of the process.”

Top Global Stock Picks

From a sector viewpoint, and as of April 25, technology is the fund’s largest weighting at 23.0%, followed by financials at 15.8%, healthcare at 12.3% and consumer discretionary at 11.4%. The bent towards technology is reflected in the fact that six out of the top 10 names are technology firms, such as NVIDIA Corp (NVDA), Microsoft Corp. (MSFT) and Meta Platforms Inc. (META)

Running a portfolio with about 70 holdings, Elliott highlights Boston Scientific Corp. (BSX), a medical technology firm that has a focus on cardio-vascular products, but also produces equipment for surgery and neurological conditions. “They have some real innovative technologies, including Farapulse, a system used for pulse field ablation and atrial fibrillation. This new technology essentially blows out the short-circuiting cells that cause the arrhythmia, while sparing other cardiac tissue. It was approved in January and has had a gangbusters launch. We are very positive on Boston Scientific.”

The stock is trading at US$73, versus US$58 at the start of the year. The stock is trading at a lofty 28 times 2025 earnings. But Elliott notes that it has a very strong organic growth rate. “This is definitely a growth stock. We saw a pipeline and a large market opportunity and and it’s got a great management team.”

Another pick, Bawag Group AG (BG), is an Austrian bank that operates in Western Europe. “It’s one of the most efficient and best run banks in Europe and enjoys a 25% return on tangible common equity last year. There isn’t a lot of opportunity for loan growth right now,” says Elliott. “But the management are great capital allocators and have done share buy-backs and bolt-on acquisitions. They’ve been able to continue to generate capital and return it to shareholders.”

The stock is trading at 57.50 Euros ($83.40), or around 6.5 times 2024 earnings. It also generates an 8.7% dividend yield.

“This highlights our point that we’re not looking for value names or growth names,” argues Elliott, noting that the macro view is entirely different for both stocks. “We’re looking for names that work in their sector. Boston Scientific has a great story and a great product pipeline and will grow. Bawag is a great-run bank, with a cheap valuation and great cash flow. So, we can also make money there.”