The Upside of Canada’s Economic Woes

Kevin McSweeney - Apr 30, 2024

In moments of pessimism, great returns can be made in the stock market. Uncover how Canadian investors’ negative outlook may drive stock performance as the economy stabilizes.

Living in Canada, most of us are aware that over the past year and a half to two years interest rates and inflation have dominated the economic discussion around here. Whether it be through our own financial lives, whether it be through seeing a declining housing market or whether it be through going to the grocery store and looking at and becoming enraged by elevated prices, the mood of Canadians with regards to their own economy has been very pessimistic. This is reasonable, especially given our neighbors to the south have seen stronger stock markets in the last year as well as declining unemployment, rising wages and, in 2023 onwards, growing per capita wealth.

With that backdrop, it seems natural that Canadians might be concerned about their stock market or feel that we are going to remain in an inferior return position to the United States or other major markets. It's in moments of pessimism that a lot of great returns are made in the stock market. When everyone is optimistic, that tends to be the time when stocks might be overvalued, or people have already bought and don't have cash on the sidelines to fuel a new stock market rally. In Canada, I think the next couple of months will bring better economic news and relief on the interest rate front.

Although the stock market follows the economy over time, there are times that the economy and the stock market can diverge. In Canada, the Toronto stock market is made up of a very different set of sector weights than the economy itself. In the Canadian stock market, consumer stocks are only approximately a 7% weight, whereas in the economy the consumer has 55% of the weight. Consumer weakness within Canada does not mean stock market weakness.

In the coming months we are confident that the Bank of Canada will need to cut rates in order to address economic weakness and disinflationary impulses across almost all areas of the economy. In fact, inflation is already below 2% if one excludes the impact of mortgage interest costs caused by the Bank of Canada’s interest rate hikes themselves!

Once it becomes clear to Canadian investors that a 5% GIC is almost impossible to get, Canadians looking for reasonable returns will migrate to stocks, corporate bonds or preferred shares that continue to offer up healthy yields. As well, we think that once the rate cutting cycle begins, international investors will become more aware that Canada is very unlikely to face a housing crash, and this will restore confidence in their ability to invest in Canada's banks where financial services make up approximately 30% of the stock market value.

Within the Canadian Equity Alpha strategy, we remain committed to the Canadian stock market with a diversity of industries, whether it be utilities or miners, banks or telecom companies. While each of those have different drivers of their earnings, we think each of them can do well as the Canadian economy stabilizes and the cheap valuation of Canadian stocks causes investors to take notice and buy.

IMPORTANT DISCLAIMERS The opinions expressed in the communication are solely those of the author(s) and are not to be used or construed as investment advice or as an endorsement or recommendation of any entity or security discussed. This document is provided as a general source of information and should not be considered personal, legal, accounting, tax or investment advice, or construed as an endorsement or recommendation of any entity or security discussed. Every effort has been made to ensure that the material contained in this document is accurate at the time of publication. Market conditions may change which may impact the information contained in this document. All charts and illustrations in this document are for illustrative purposes only. They are not intended to predict or project investment results. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Global Asset Management and the portfolio manager believe to be reasonable assumptions, neither CI Global Asset Management nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise. Certain names, words, titles, phrases, logos, icons, graphics, or designs in this document may constitute trade names, registered or unregistered trademarks or service marks of CI Investments Inc., its subsidiaries, or affiliates, used with permission. All other marks are the property of their respective owners and are used with permission. © 2023 Morningstar Research Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI Global Asset Management has taken reasonable steps to ensure their accuracy. Market conditions may change which may impact the information contained in this document.