Equity Market Update

Head of Investment Strategy Neil Linsdell joins host Chris Cooksey to discuss what’s going on in equity markets, including:

• Q2 quarterly update highlights
• Interest rate cuts
• Differences between US and Canadan
• Recession?
• Issues in the housing market

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Transcript

Chris Cooksey: Welcome to the Advantaged Investor, a Raymond James Limited podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long term success. Today is May 3, 2024, I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department, and today, Head of Investment Strategy, Neil Linsdell returns to the podcast.

Welcome back to the Advantaged Investor, Neil. I hope you're doing well today.

Neil Linsdell: Yeah. Great. Thanks for having me again.

Chris Cooksey: Excellent. Now January was the last time you visited, and we recapped 2023, if people want to go back and listen to what we were saying then. And I do believe one of the things we talked about was inflation and how it was trending back towards the level that they want, around 2%. And I think we were talking about, at the time there were people out there saying they were expecting five or six rate cuts in the U.S. January isn't that long ago, but I do believe things have changed since then. And you recently published your Q2 update, so why don't you run through the highlights to that?

Neil Linsdell: Sure. Well, you're right. Expectations on interest rates have shifted a lot in the U.S., but in Canada, we're trending pretty much in line with what we expected. So we can take a look at some of that divergence. We did publish our Q2 update a couple of weeks ago and the key takeaways are that we're still looking for GDP growth to slow both Canada and the U.S. and for interest rate cuts on both sides of the border. Economically in Canada, the year did start out relatively well, but February was a bit weaker than consensus expectations and the flash estimate for for marked points to a slowdown than in the momentum leading into the second quarter the Bank of Canada did recently upgrade its 2024 full year GDP forecast to 1.5% growth up from 0. 8% was their forecast in January. So there's a little growing optimism. But we're still looking at a recession this year, likely in the second half. Although that could hinge on, on how quickly the bank lowers interest rates. Now, when I say recession, we're still talking about a mild recession. So modest contraction of GDP, do expect to see further increases in the unemployment rate? Nothing dramatic. But we're still watching for these high interest rates, putting pressure on consumers and that's still working its way through the economy with those, you know, infamous lags.

Chris Cooksey: I imagine this pressures businesses as well, and I assume that's why you expect maybe the unemployment rate to be impacted.

Neil Linsdell: Yeah, exactly. So businesses are growing more cautious with this about their revenues. And as the population in Canada is growing dramatically, job growth is not just keeping pace with that. In fact, if we looked in the last business outlook survey and concerns about sales are actually the fastest growing concern among businesses, while issues like we've talked before about labour shortages, supply chain, cost pressures - those are all in decline. The labour market isn't as tight as it used to be and the unemployment rate in Canada was last reported at 6%. So that's up from about 5% last year. Again, nothing to panic about - the long term average is around 8%, but we are seeing a deterioration. As the unemployment rate starts to pick up a bit and, you know, there's more uncertainty and that continues to spread.

Chris Cooksey: All right. And you know, our friends to the south of the U.S., sounds like their environment is markedly different shall we say?

Neil Linsdell: Yeah, absolutely. The U.S. has been much more resilient in, in many respects. GDP is stronger. So we had 3.4% in Q4 weakened a little bit in, in Q1, 1.6%, but still a very decent growth there and their unemployment rate, we actually had a new jobs report out this morning, so they have a much lower interest rate at sorry, an unemployment rate, 3.9% that was up a little bit from 3.8% last month. It's still a relatively tight market and that might be one of the reasons the U.S. is having a little bit more challenging time with inflation. The U.S. inflation rate has actually picked up recently, such that it's actually started to raise some concerns that the U S. might start hiking rates again. Since the last week the last number CPI we had was 3.5%, in the U.S. core PCE 2 8%. Those were above expectations and stubbornly sticky. Jerome Powell the chairman of the Fed made some comments this week that inflation still remains too high, obviously, but the Fed sees that the current rates are sufficiently restrictive and that it's unlikely the next policy rate move would be a hike. So that took the prospects and the potential for rate hikes off the table, but it's clear that the Fed has a time. They could take some more time. Watch the data before committing to reducing rates. Right now, expectations are generally for one rate cut this year. Our U.S. team is forecasting two and interestingly, that weak us jobs report that I just mentioned that came out this morning, we actually had nonfarm payrolls growing only by 175,000 in April, so the expectation was for 240,000 - the economy is weakening a bit, employment's not as strong and that suddenly raised the, the potential, the enthusiasm that the Fed might have more leeway to cut sooner. O sentiments can shift on a dime here.

Chris Cooksey: Fair enough. Now, we had our colleague Harvey Libby on the last episode, and he was talking about his expectations around bank cuts in Canada, and he was suggesting it might be June, so I'm going to assume that the inflation story is a little bit better here in Canada because of these rate hikes?

Neil Linsdell: Yes. In Canada, we've seen a relatively steady progress on inflation. And total CPI is/has actually been below 3% for three months now, as it moves down to that magical 2% percent level and is arguably already within the 1 to 3% comfort band that the Bank of Canada has. But you have to remember that there's CPI, CPI, trim, CPI, median. So there's different ways to calculate inflation in Canada. And each one of them excludes certain different volatile items. We did published some more detail in our April monthly Insights and Strategies report, you can go back and take a look at that. But basically what we explained - if you remove the impact that high interest rates are having on mortgage payments, we'd already have an inflation rate that's below the Bank of Canada’s 2% target. So think about that. If high policy rates are meant to reduce inflation, but they're actually adding to inflation by increasing the shelter cost component of our inflation measure, wouldn't you think that we should be lowering interest rates at this point?

Chris Cooksey: Yeah, that would sound good to me. As I've said many times, my variable rate mortgage would enjoy the reduction - do you think then, as our colleague Harvey does, June is the time it starts?

Neil Linsdell: Yes, I, I'd agree with Harvey on that one, the the market seemed to be torn between expectations of the easing cycle in Canada, starting either June or July. But I think the bank can and should, as you're mentioning, lower the rate starting in June. Don't forget that we're already seeing pressure on the economy, and the longer that you wait to lower the rates, there's more mortgages that are going to end up renewing at higher rates than they could have been. There's more pressure on consumers. Plus, we explain in our report, inflation is already at or below the target rate. If you make some very reasonable adjustments on how you measure it, then there's no reason for the overly restrictive policy that we have now. So yes, I definitely lean towards a June cut.

Chris Cooksey: All right. We have a lot of snowbirds here and they need U.S. dollars, and if we start cutting rates and the U.S. does not, how does that affect the currency right around or probably in the fall when people start returning to their Southern homes?

Neil Linsdell: There's definitely a possibility that that's going to impact currency. There's a lot of factors that go into foreign exchange rates but the difference in interest rates is certainly influential. We're looking at both the the ECB and BoC to the lower rates before the U.S.at this point, and that should weaken the Canadian dollar against the U.S. dollar, but there's a few impacts here to consider. So if that does occur what happens? You risk importing goods inflation to Canada. So anything that you import from the U.S. at that point would make those products more expensive in Canadian dollar terms. And so that can, that can boost inflation in Canada. But you also make Canadian exports more attractive to the, to the U.S. market, right? Because they become less expensive in U.S. dollars. That potentially helps GDP. Ultimately you don't want the rates to be too different. So the Bank of Canada governor actually commented on this this week in front of the House of Commons finance committee. He admitted that there is a limit to how far the U.S. and Canadian interest rates can diverge, but that we're certainly not close to that limit right now. I take that as a signal that the Bank of Canada is not going to hold off on rate cuts just because the Fed might not be ready to start their easing cycle.

Chris Cooksey: All right. Now, to summarize, I guess, GDP's been stronger in both countries, stronger than expected, it is weakening, you're still looking for that mild recession coming up towards the end of the year, and there likely will be further increases to the unemployment rate. Do I have that all correct?

Neil Linsdell: Yeah, exactly. If we go back and we look at the differences from what we wrote just three months ago in January, now we think the U.S. will avoid recession. So that's probably some of the big things and we're looking more towards a soft landing scenario because we have seen you know, significant strength in GDP there and that for the most part, the expectations for rate cuts in the U.S. are lower, so less rate cuts, pushed out more towards the end of the year.

Chris Cooksey: Okay. So that's got to be influencing equity markets in some way. We have been on quite a run since the fall, October of last year, and you let me know that April was our first negative month since then. So. What does that portend?

Neil Linsdell: Yeah, well, that's, that's right. I mean, both the TSX composite and the SP 500 they were down in April, but you got to remember that was after five positive months. So TSX was down 1.8% in April, S&P 500 was down 4.2%. Now, again, you have to put that into perspective. The S&P 500 was up around 27% from October and the TSX was up around 20%. So if you had to expect some kind of release, some kind of pressure taken out of the system here and we've been talking about increased volatility, given the significant returns that we've seen over the last year or more, and don't remember, you know, remember volatility works both ways. So this is all relatively normal. You're going to get this type of volatility in the stock market. But now, as we're in the thick of earning season we're looking at earnings and for the most part, earnings have been strong. Now the fact that rates may stay higher for longer, at least in the U.S., that can weigh on equity valuation multiple. We do only expect modest improvement really on equities through the end of the year. But with that soft landing scenario, still good economic growth. Yeah. overall good earnings. You know, the multi-year outlook remains quite positive. And if we look at valuation multiples. Valuation multiples in Canada they've been more conservative than in the U.S., as they typically are. Right now, PE multiples on the comps is around just over 14 times, just around 20 times in the U.S. That's higher. A lot of that has to do with the magnificent seven. EPS growth expectations in Canada are also lower around 5%, you know, 2024 over 2023. In the U.S. it's about 11%. There's always a lot of give and take in the markets. You can't forget that, you know, timing the market is difficult, if not impossible. So it's best not to try and get fancy and just to stick to good quality investments that serve you well in, you know, the longterm.

Chris Cooksey: As you say, it's important to really look at the whole story rather than the one negative issue or the one overly positive issue, and I'm going to assume you agree with me, that the best person Individuals can talk to is the Raymond James advisor.

Neil Linsdell: You took the words out of my mouth.

Chris Cooksey: Now you touched on mortgage rates earlier, in the recent federal budget we saw a lot of focus on housing and obviously the press has been all about housing affordability and whatnot, you have published a few commentaries on this subject in the last few months. Do any of these initiatives affect your forecast?

Neil Linsdell: Well, I mean, you're right. We have been writing quite a bit about the housing crisis in Canada, which is really about both availability and affordability. Although it's great to see initiatives to support housing, we really don't see that much immediate relief. The problem is really between supply and demand. Last year we saw the population of Canada grow by 1.3 million people - really unprecedented growth and all those people need somewhere to live. On the other hand, we have seen the number of housing starts in a steady decline since, you know, 2021. Even the CMHC update from this week forecast that housing starts will decline further in 2024, below the current number of 240,000 we saw in 2023, although the population growth continues unabated and the government's plans to reining in that population growth seem to transition in from 2025 to 2027. Back in October, when we first wrote about the housing crisis, we estimated that we need to build roughly 650,000 homes per year. That was starting immediately in order to move towards the government's affordability targets. So six months later, THE situation only looks worse. So I don't see any immediate relief and it takes quite a while to build new homes, especially multifamily units or apartment buildings. you need to coordinate that between multiple levels of government? No small feat, given that any kind of government initiatives will take time to trickle into the market and that the interest rate environment uncertainties, not necessarily conducive to developers taking on additional risk. The supply demand balance has little chance for improving in the very short term, so I'm not sure we even have enough construction workers to achieve the growth rates. We need to hit those those targets actually. So so it's definitely something to watch. We don't see any short term fixes unfortunately> It is good to see initiatives on that theme, but not a lot of immediate help, unfortunately.

Chris Cooksey: Well, that was fantastic news. Neil, thanks for that.

Neil Linsdell: End on a high note.

Chris Cooksey: Yeah. I'm not a math guy, but even I can see that equation doesn't work out. Hopefully shovels get into the ground as they say. I just want to thank you for taking the time today, Neil. Really appreciate you allowing me to some of your time and we'll talk again next quarter.

Neil Linsdell: Great. That's a lot for having me again.

Chris Cooksey: Reach out to us at advantagedinvestorpod.ca. Subscribe through Apple, Spotify, or wherever you get your podcasts. Please contact your advisor with any questions you have. Thank you for taking the time to listen today. Until next time, stay well.

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