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Insights and Strategies

Expecting Volatility

As we move towards the end of the year, we continue to debate how this cycle will end, between the soft landing, mild recession, or deep recession scenarios. Our base case is for mild recessions in both Canada and the U.S., and that inflation-fighting central banks will keep rates higher for longer than many might expect. Although inflation has come down dramatically from its peak in June 2022, the battle to two per cent could drag well into 2024 or 2025, and although we believe we are near the end of the tightening cycle, any short-term resurgence in inflation could prompt further interest rate hikes through the end of 2023. The risk of overtightening remains and as global economic growth is already slowing, this could put even more pressure on the economy.

Now, the stock market is not the economy, and is generally more forward looking, but stocks can still react in the short-term to earnings surprises and guidance revisions. This can set the stage for security prices to be more volatile as we see mixed signals between low unemployment rates with still tight labour markets, and resilient consumer spending including continued demand for travel and entertainment, but with shifting spending patterns as shoppers favour value and trading down. We also see purchasing managers indicating declines in new orders as profit margins start to be squeezed, although many companies are also apparently increasing investments, specifically in technology, to improve efficiencies. This could lead to volatility in the market that might rattle some investors, but be seen as buying opportunities by others. Overall, we remind investors that volatility is inherent in public market investing and that it is important to maintain a long-term plan suited to one’s specific goals and risk tolerance.

In the table below, we track monthly changes to EPS 2023 estimates for the S&P/TSX composite index. The forward-looking earnings measure has been consistently declining since the most recent market trough in October 2022, suggesting that analysts are factoring in the pressure on earnings expected from this economic slowdown. The number of companies that have seen negative revisions is also increasing. Although one might expect this deteriorating forecast to pressure share prices, the TSX composite is actually up ~7% from the end of September, and essentially flat YTD. The P/ENTM multiple has increased from 11× in September 2022 to 12× in January and 13× today, while still below the 14.5× median, suggesting improving sentiment as investors look forward.

TSX Composite and NTM EPS Moving in Tandem [LHS]; While Lower EPS Forecasts Reflect More Cautious Outlook [RHS], Source: FactSet; Raymond James Ltd.; Performance data as of August 15, 2023. Earnings revisions data as of July 31, 2023. Data labels indicate the number of constituents have upward/downward/unchanged earnings revisions. Please be advised that the 2023E EPS data might not be accessible for all constituents, and the number of companies with accessible 2023E EPS decreases when moving further into the past.

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Market Commentary