Q1 2024 Market Commentary: Persistent Inflation, Strong Economic Growth, and Rising Interest Rates
Vittorio Ciccone | M.Sc | Louisbourg Investments
Since the start of the interest-rate cycle, we’ve witnessed two interesting phenomena: the resilience of the US consumer vs. those of other economies; and the continued outperformance of the overall US economy vs. those of other regions.
Because of this resilience, the inflation trends that started slowing last year may now be reversing. Staying true to form, though, the US Federal Reserve continues to expect a downward turn in interest rates.
However, if the run of stronger economic numbers does continue in the US, it could put any initial rate cuts this summer in jeopardy. Some economists now argue that, contrary to the multiple rate cuts expected this year, there will be one rate cut.
In contrast to the US, we see Canada’s economy significantly underperforming. Canadian gross domestic product (GDP) did look strong in Q1, beating some expectations. But when we overlay this data with the population growth, the measure becomes less impressive. The Canadian economy has also seen the unemployment rate tick higher – outpacing those of other developed economies. This, in turn, puts the Canadian central bank in a position, possibly the strongest of developed countries, to begin cutting interest rates this year.
In her commentary below, Louisbourg Investments’ Head of Fixed Income Heather Hurshman explains how the lower quantity of rate cuts, combined with stickier inflation, led to the rise in 2024’s first-quarter yields.
Meanwhile, Mathieu Roy, Louisbourg’s Head of Equities, explains how the feeling that the rate-hiking cycle is shifting to a cutting cycle has led to continued strength in the equities markets. With the growth in the economy despite central bank intervention, investors are now thinking “no landing,” that is, the growth will continue.
Equity Markets
While we experienced some notable investment sentiment shifts during 2023, we certainly finished the year on a positive tone. This excitement persisted as we kicked off 2024, with investors enthusiastically buying risk assets. A resilient economy, combined with central banks seemingly ready to soften monetary conditions gave investor confidence that conditions will be strong for corporate profits. In essence, momentum in equities continued in the first quarter as investor optimism around a so-called “no landing” scenario continued to grow. All main equity classes benefited, with US, International and Canadian equities offering generous returns.
While Canadian equities lagged its global peers in the first quarter of 2024, the asset class still generated a strong 6.6% return for its investors. The breadth across the S&P/TSX sectors was wide with nine of eleven sectors contributing positively. The most impressive performance was generated by Health Care (+18%), but this sector is quite small in Canada. Energy (+13%) and Industrials (+11%) were the most impactful sectors given their size, as investors positioned themselves to be more economically sensitive. It also helped that WTI spot oil price climbed 15% to $83 during the period. Communications (-8%) and Utilities (-1%) did not join the party as investors shied away from defensive companies and worried about increased competition in the Telco space.
US equities continued to lead the world, up 10.5% in USD, helped by their strong exposure to technology/semiconductors. The strength of the US dollar against the loonie also helped the return, with US equities finishing the quarter up 13.5% in CAD. On a sectoral basis, the rally was once again driven by a growing appetite for risk. Communication Services (+16%) was the main outperformer, led by Meta and streaming services (Netflix & Disney). This was followed closely by Energy (+14%), Technology (+13%), Financials (+12%), and Industrials (+11%). Recession-resilient sectors were the main laggards, with Utilities (+5%), Consumer Staples (+8%), and Health Care (+9%) all underperforming the index. Real Estate (-1%) also underperformed as investors remained cautious about the sector's prospects.
International equities also performed strongly, up 8.5% in CAD, but lagged their US peers given the lower exposure to technology. The weakness of the Japanese YEN weighed on performance for Canadian investors. On a sectoral basis, the rally was also driven by a growing appetite for risk. Technology (+17%) was the main outperformer as excitement around Generative AI demand continues. This was followed by Consumer Discretionary (+14%), Financials (+12%) and Industrials (+11%). Recession-resilient sectors were the main laggards, with Utilities (-2%), Consumer Staples (-1%), and Health Care (+8%) all underperforming the index.
Fixed Income Markets
The first quarter of 2024 started the new year with a return to an old story in bond markets as elevated inflation, strong economic growth, and higher interest rates were a common theme once again. More than half of the decline in bond yields during the last quarter of 2023 was erased this quarter as yields rose steadily throughout the period. Several catalysts were involved in this repricing, causing the market to move toward the view that central bank interest rate cuts were not on the immediate horizon and there would also be fewer cuts than the market had priced in at the end of last year. Reasons for the retracement to higher bond yields this quarter, other than the likelihood that the market got ahead of itself in the prior quarter, included added optimism for economic growth, positive performance in financial markets, elevated wage growth and rising commodity prices. Inflation pressures are coming down slowly but remain too high for rate cuts to be introduced until further inflation readings can confirm central bankers are closer to the 2% inflation target.
The relative performance of the US and Canada more notably diverged this quarter as Canada lagged the US on several fronts including weaker economic growth, negative productivity, higher unemployment rising steadily and weaker than expected inflation readings. In Canada, the most recent headline CPI measure of inflation was weaker than expected at 2.8% Y/Y (Feb) and the Core Median CPI rate was 3.1% Y/Y (Feb) while the US had a headline CPI rate of 3.2% Y/Y (Feb) and Core CPI of 3.8%. The unemployment rate in Canada has been rising steadily with the labour market moving from a net excess demand position in 2022 to a net excess supply position of 390k. Rapid population growth and declining economic growth in Canada have contributed to the rise in the unemployment rate which was 5.8%. Last year GDP growth in Canada was 1.1% while the US generated growth of 2.5% over the same period. Annual growth is expected to remain in positive territory in 2024, with Canada projected to grow by 1.1% and an economic growth in the US of 2.3%. However, the recent strength in commodities may push the growth picture higher this year in Canada.
This quarter, central bankers did not change their messaging from the previous quarter where they confirmed that they see their next move as being a rate cut, but they did give greater clarity to the market in terms of being in no rush to do so. They indicated that time and additional readings of decelerating inflation was the key criteria for timing a rate cut. This caused a repricing with the market moving out expectations for a rate cut to mid 2024 and reducing the degree of expected rate cuts this year to total 75 basis points. During the quarter, bond yields rose and the curve steepened as two-year Canada bond yields increased 29 basis points to 4.18%, while five-year yields rose by 35 basis points to 3.53%. The ten-year Canada yield increased by 36 basis points to 3.47%, while thirty-year yields rose by 32 basis points to 3.35% over the same period.
As always, for more information about Ciccone-McKay Financial Group, or if you want to chat with someone at the firm, we welcome your call: 604-688-5262.
