Equity update | A review of 2023 and a look at how 2024 is shaping up
Head of Investment Strategy Neil Linsdell returns to the podcast to discuss equity markets, including:
- The market at end of 2023
- Interest Rates
- Balance portfolios and other opportunities in 2024
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Chris Cooksey: Hello, and welcome to the Advantaged Investor, a Raymond James limited podcast, a podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long term success. We are recording this on January 16, 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 to review 2023 and give us an indication of what may be in store in 2024. Neil, welcome back to the podcast. I hope you're doing well. It's always a pleasure to connect and have this type of discussion with you.
Neil Linsdell: Yeah, great. Thanks for having me.
Chris Cooksey: All righty. As you know better than I, there's a lot to jump into when we look at a full year and maybe review a bit of the last one, so we'll jump right in and maybe before we get into your 2024 outlook, let's do a quick recap of 2023.
Neil Linsdell: Yeah, good idea. So 2023 spent most of the year of inflation fighting. That involved very aggressive increases in interest rates. Let's go back to economics 101. You’ll recall that inflation comes about when you have too much demand, not enough goods and therefore prices get bid up. You'll probably also recall that back in 2020, the world was in the throes of a pandemic, which among other things disrupted supply chains, if you were looking for a certain car part or appliance, or even toilet paper at one point if you recall, remember that the supply chains that brought those products, from manufacturing to transportation to store shelves was in some cases put into chaos, right? So at the same time, as some people lost their jobs or face restrictions on their ability to earn income, the government stepped in with stimulus cash, providing more money for people to use. But remember, there were less opportunities for them to spend. So high demand, low supply, prices go up. It was really around April or May of 2021 when inflation broke out above that one to three percent range that the Bank of Canada likes to hold into. At first the expectation was that that inflation was just transitory, right? A supply chain has got back to normal, that inflation number would come back down. It seemed reasonable as inflation numbers were also, they're also a year over year measure, right? If you're comparing those to the previous 12 months since the pandemic began, we were comparing to very low numbers and even negative numbers - we were just maybe averaging out. Well, inflation continued to creep up and by March 2022, we were looking at inflation around six percent and the Bank of Canada decided that they better act and even maybe make up for some lost time.
Now you have to remember that when you hike interest rates to combat inflation, there's an 18 to 24 months lag before changes in monetary policy impact the real economy. With inflation rising rapidly, it didn't have a lot of time to waste, so we started out from a base, if you recall, of just 0. 25%, that was the policy rate, the Bank of Canada increased rates to five percent between then and July of last year. Over 16 months, and this was also going on in the US so whether it was the tighter monetary policy or just supply chain problems taking longer to sort out or a combination, inflation peaked at around eight percent in June 2022, but then started to fall quickly. I should mention here that headline CPI, consumer price index, that we quote is a volatile measured in the bank has preferred measures of CPI that ignore some of the more volatile components like energy. You can imagine how wildly your gas prices can swing at the at the corner service station. The Fed in the U.S. does this as well. So sometimes we're talking about core inflation. And so that core inflation number has followed the same path as the headline numbers, but it's not been quite so extreme. In Canada, we've measured the peak around 5-5 ½ percent, but still well above that two percent target and the comfort band of 1 to 3%. So fast forward as we exited 2023, those measures are generally been around 3-3.5%. And this number this morning, we just had the inflation come out at 3.4%. So we're still within that band for now. So, well, Prices for goods have generally more normalized services. Inflation is still quite high, and we've seen a lot of negotiations and strikes related to wages, so you can imagine that it continues to be a source of pressure on on the inflation rate, right?
Chris Cooksey: So in terms of inflation, like you mentioned, it's 3 to 3. 5%. The target is 2%. The number that came out this morning, I saw in a headline that it was a little bit higher than what's expected, so maybe this will answer the question that I'm going to ask you now, are we close enough to 2 percent and can we start cutting rates in my variable mortgage again?
Neil Linsdell: Well, a lot of people would agree with you. But you got to remember the bankers are still concerned about a rebound in inflation, right? We're seeing the number tick up, but there was expectations it was going to take up anyway, because you're always working on a year-over-year comparison. But nobody wants to see a restart of those rate hikes, right? Overall, we're seeing this inflation, so inflation numbers are coming down, looks like it's continuing to go in that direction overall, but bankers are still a conservative bunch, and they want to see the data that supports that before making any decision.
The bigger risk to them is that inflation restarts. We've seen some considerable softening of language over the last few months where they're not quite as hawkish, as we'd say. It's looking pretty certain that we'll see those inflation numbers continue to come down over 2024, but not necessarily hitting our two percent target, maybe until 2025.
But the question is when do bankers have enough confidence to reduce those rates without worrying about inflation picking back up? Moving too quickly introduces the risk of inflation picking back up, the risk of waiting too long can result in more economic stress on businesses and consumers, like yourself as you're worried about your mortgage renewal coming up. So now the interest rates, the increases were intended to slow the economy and that's been happening to allow supply to catch up with demand. But causing too much pain, could cause consumers to stop spending dramatically and then companies scale back production and employment - you've got job losses. So it's definitely a challenging balancing act. Right? Now, we do think that rakes rate hikes are over and that we’ll see enough data and progress on inflation to start showing that we're on a solid path to that two percent inflation target and that bankers will start lowering rates, but maybe not until mid 2024 at this point. So we also see the economy weakening, but we still got relatively tight labour markets. We haven't seen those spikes in employment numbers, so we don't see a lot of layoffs. We see some trimming, a reduction of hiring, all this combined, we think it should lead to a relatively mild recession compared to what people might be thinking about.
Chris Cooksey: Now we had our colleague Harvey Libby on the last episode, and he was mentioning similar sentiment regarding rates. So glad you guys are on the same page, first of all but he also was talking about rate cuts as well, so would you say it's a broad expectation that rates will come, I mean, they're eventually going to come down anyway, that's just a function of the markets. They go up, they go down, but would you say that the broad expectation is rate cuts?
Neil Linsdell: Yes, it's mostly a matter of when and how much, right? So if we look at the financial markets, Harvey talking about the fixed income markets, there's the expectation right now kind of built into the market is we're going to get five or six rate cuts in 2024, maybe starting as early as March - I think that might be a little bit optimistic. I'd be more inclined to think about three to four rate cuts and mostly towards the end of the year as we start getting some of that economic data. And as long as the economy is not hurting significantly, so we're not seeing major significant rises in unemployment, central bankers have the luxury of taking their time on those rate cuts. If on the flip side, if we start to see more dramatic recessionary impacts - you start to see the layoffs, you start to see the significant slowdown and consumer spending, then yes, bankers might move to cut rates earlier to minimize the economic damage, avoid that sharp rise in unemployment, stimulate the economy a little bit more. But we don't necessarily want to see rate cuts for that reason. We want a more controlled normalization and that would be better for everybody involved.
Chris Cooksey: Now in terms of investments, obviously when rates are a certain level, some people may leave the market and go towards a more fixed income because the rate is It's enough for them. If these rates start coming down, what does that mean for investments? And you know, maybe just start with what was going on last year with the current environment and then get that old crystal ball out, Neil, and polish it well and let us know.
Neil Linsdell: Yeah, the crystal eight ball. So, you'll probably recall in 2023, mostly what we were talking about was the S&P 500, the magnificent seven driving the S&P 500 index in the U. S. The magnificent seven, that's Apple, Microsoft, Alphabet (Google), Amazon, NVIDIA Meta and Tesla. So those seven companies represented about 30 percent of the weighting of the S& P 500 and the other 393 companies representing the other 70%. These stocks significantly underperformed in 2022. So part of this huge rise in 2023 was recovering from those losses to a certain extent, but we also had a lot of enthusiasm about artificial intelligence last year. You probably recall and that helped to breathe a lot of life into these stocks. So as a group, these stocks were up around 85 percent last year, while the rest of the market was up around seven or seven or eight percent. So from the perspective of Canadian investors, if we look at the total returns after dividends for an exchange investing in the S&P 500, you would have had about a 23 percent gain, again because of the magnificent seven, while the S&P/TSX Composite index returned about 12%, just under 12%. And a lot of that action actually happened because we had a huge rally over the last two months of 2023.
Chris Cooksey: That's interesting too, you had a few stocks driving it. If you were a little risk adverse, you avoided the technology names, your gains would be significantly different than 23%. Now I think it's safe to say that 2024 is looking a little calmer, so are we looking at similar gains for this year, potentially?
Neil Linsdell: First of all, I think we are going to get a broadening out of the market rather than concentration on magnificent seven, as we start to look at the broader economy. But there's a lot of excitement right now, I think, about rate cuts. And a lot of confidence that the U. S. economy is going to avoid recession. We're a bit more conservative on both fronts. While I think we should see positive returns this year, I also think it's going to be more volatile, maybe single digit returns might be more reasonable than the returns we saw last year. And the reason being for that is that the market, we did have that run up over the last two months of last year, so you have high expectations in the stock market. And right now, if you look at the, the consensus analyst expectations, so all the analysts in the US, expectations for all the stocks in the S&P 500 right now, it works out to $245 USD.
Our us team is forecasting about $225 USD, which is probably more aligned with pressure that we'd expect to see on corporate earnings during a mild recession, right? When the consensus might be for more of a soft landing. Now, analyst expectations tend to come down about four percent over the course of the year on average. So maybe the consensus number is going to go from$ 245 to $235 USD, so that's going to come down closer to our number. Offsetting that, you have to remember the financial markets look forward, but financial markets aren’t the economy, the economy aren’t financial markets, but they rhyme, but the markets tend to move in advance. Even though we've got a mild recession scenario, investors will be looking towards the growth maybe in 2025 and be more generous on those valuation multiples, even if the EPS is down or more compressed. With a reduction in interest rates, you also have a lower discount rate when you're applying that to future earnings that puts higher valuations currently, we think that balances out to positive, but probably more modest returns than last year in the equity market.
Chris Cooksey: That makes sense. Now, in terms of fixed income, declining rates usually make bonds more attractive. Is that the case we're looking at 2024?
Neil Linsdell: You've been paying attention to Harvey.
Chris Cooksey: Yes, exactly. I don't want his head to get too big. So I won't admit that.
Neil Linsdell: Yes, this is actually a really good environment for fixed income. So probably better than we've seen over a decade, 15, maybe 20 years. So right now, we've got yields that are close to what you can get on conservative equities at some point. Plus, as you mentioned, as interest rates fall, the value of those bonds rise as your yields become more attractive in the current rate environment.
Chris Cooksey: Because you can't replace those bonds at the same interest rate at this stage within a declining rate environment.
Neil Linsdell: Yeah, you'd have to pay more for them, so the value goes up.
Chris Cooksey: All right. So sounds like you're fairly positive on both equities and fixed income/bonds in 2024. Are we looking back at the old 60/40 type balance portfolio situation or what's your call there?
Neil Linsdell: I think that's a good approach. First off we know equity markets can be volatile, but they'll tend to provide you higher returns overall over the long term. We do have a lot of geopolitical tension in the world. I'm thinking primarily escalating tensions and the Israeli Hamas war. If that conflict escalates or spreads, then we could see effects, rising oil prices could impact economic growth and inflation. A lot of these things could be risks on the horizon. Ultimately a well diversified equity portfolio held over a long period of time will serve investors well, especially with the current rate environment and with interest rate cuts on the horizon, fixed income provides you both more stable returns we talked about, plus benefits capital appreciation as the rates fall and bond prices rise. So balanced portfolios, probably a good place. As you know, we always say, your Raymond James advisor is the one that can best customize a portfolio suited to your long term objectives and risk tolerance. So that's an even better place to start.
Chris Cooksey: For sure. Now just to finish off here your annual insights and strategies piece, I believe has been released has been put out, so if you want to let us know if that's available and I also believe you will be doing a webinar towards the end of the month. Is that true?
Neil Linsdell: It's almost true. Our quarterly asset allocation report. We're just we're just tidying it up. So we're, we're expect to get that out this week, maybe before this podcast is published. So that'll be available on the Raymond James website. We also have our collection of monthly insights and strategies reports, we started out with looking at the electrification going on - 2024 and an electric new year. We look at those, we'll be exploring more themes like that on a monthly basis. And yes, we will as soon as we get that out, we'll be scheduling a client insights call to elaborate on that.
Chris Cooksey: Perfect. And as Neil mentioned, available on raymondjames.ca or you can check out our social media and we will definitely be linking to it there. Neil, thanks for taking the time today. Very informative as always, and I look forward to speaking with you again soon.
Neil Linsdell: Thanks. Great to be here.
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