Q1 2024
The first quarter of the year is in the books, and we have some thoughts to share with you.
Inflation continues to trend lower, interest rate cuts seem to be on the horizon, and the U.S. economy continues to demonstrate strength. To top it all off, it has been a nearly unprecedented winning streak for the U.S. stock market. The S&P 500 has surged 25.3 percent since the October 2023 low.
The economy
The U.S. economy has held up particularly well over the past year despite all the monetary tightening, a regional banking crisis in early 2023 and a war in the Middle East. This is in part due to lower interest-rate sensitivity and in part because of particularly strong consumer spending and fiscal support. The expectation that the U.S. economy will enter a recession has decreased and indicators now point more towards a soft landing.
Non-U.S. economies have struggled more in this environment, as was evidenced by slowing growth in most major regions over 2023. Canada’s GDP flat-lined in the second half of last year, while the economies of Japan, Germany and the UK fell into technical recessions, which are defined as two consecutive quarters of declining real GDP. The U.S economy managed to continue expanding at a healthy pace throughout last year and even accelerated in the second half of 2023.
Taking a closer look at Canada’s specific issues, we have a high sensitivity to interest rates due to elevated household debt and low housing affordability. When paired with higher interest rates, this explains Canada’s recent economic struggles. Additionally, Canada’s rate of population growth has led the developed world in recent years, with more than 1.25 million residents added in 2023 alone. This expansion of the population base has added to Canada’s overall economic growth rate via increased demand, but with adverse consequences that include diminished productivity and a housing shortage.
Inflation and the expected trajectory of interest rates
It is difficult for businesses, households, and governments to make plans and operate efficiently when prices are rising rapidly, but that problem has now mostly faded. Inflation has retreated from the highs of 2022, greatly reducing its corrosive effect on the economy, though there is still some work to do.
Three of the four main contributors to ultra-high inflation are behind us. The commodity shock has faded, supply chains have resolved their pandemic-era problems and central banks have removed their extraordinary stimulus. The one inflation driver that has not yet fully reversed is fiscal policy: some governments – the U.S. prominently among them – are still running large deficits, which does not help lower inflation.
At this point, the expectation is most major developed-world central banks are now likely to cut rates in 2024. Their motivation is derived from lower inflation, slower economic growth over the past year, and the simple fact that policy rates are unquestionably restrictive so there is a natural inclination toward lower rates over time.
Should the soft-landing scenario for the U.S. continue to play out, rate cuts may take longer to arrive and be more incremental in their magnitude than the market imagines. RBC analysts are currently budgeting for five 25-basis-point rate cuts in the U.S. over the next year. Of course, if a recession arrives, central banks may choose to move much more aggressively.
The markets
The S&P 500 and most other major indexes are at or have recently set new highs and could very well go even higher in the coming months.
Most large-cap stocks have been going up, not just the so-called “Magnificent 7” (Microsoft, Amazon, Meta, Apple, Alphabet, Nvidia and Tesla). As market “breadth” typically deteriorates before the stock market rolls over into a bear market, seeing most stocks in the indices moving higher is good news.
In our view, one of the main driving forces behind the strong performance has been a growing conviction that interest rates will start to drop in the coming months. A few other reasons would be enthusiasm for the prospects of artificial intelligence, solid Q4 earnings results and optimism about 2024 profit growth, on top of sturdy U.S. economic data and declining inflation.
Your investments
From a fixed income perspective, yields today have dropped from the highs of late 2023, but remain well above the averages of the past 20 years and continue to present attractive entry points. Regarding our equity portfolios, our focus on quality makes them resilient to potential economic challenges. This past quarter, there were 20 dividend increases and 1 special dividend, with another two already announced for Q2 2024.
Should you have anything on your mind you would like to discuss, please do reach out to us. If you like keeping up to date with wealth management, our website has timely articles you may want to check out:
https://ca.rbcwealthmanagement.com/bow.valley/publications
https://ca.rbcwealthmanagement.com/bow.valley/blog
We wish you a wonderful spring.
Warm regards,
Bow Valley Wealth Management Group
