In this week’s economic update, we are examining earning reports from Canadian banks, the performance of Canadian equities, as well as looking towards the future outlook and the potential of interest rate cuts.
We are also sharing insights from our in-house wealth planning expert Elvis Henrique, as he explains some of the factors you should be considering before acting in response to the proposed capital gains inclusion rate increase. Elvis explains how a focus on your needs, in conjunction with professional accountants and other services, can help prevent the 'tail from wagging the dog'.
We have included the latest Proof Point article, where Claire Fan (an RBC economist) examines the reasons for the differences in economic performance between Canada and the U.S., and why this might lead to contrasting monetary policies moving forward.
Lastly, we are providing a friendly reminder for our Summer Hours which begin this Friday, June 7th. Please find more details below.
Economic Update
Investor attention has turned to Canada over the past few weeks due to a slew of economic releases and earnings reports from Canadian banks. Below, we discuss key takeaways from these developments and reflect on the Canadian equity market’s performance this year, along with some thoughts on the outlook.
Outsized Canadian bank stock reactions
Over the past week, Canadian banks reported their second-quarter results. Much of the focus has understandably been on the outsized stock price reactions. Typically, any moves in the Canadian bank stocks related to earnings results are relatively tame and within a few percentage points of each other. But this time around, some banks saw substantial declines in their stock prices, while others were rewarded with meaningful gains.
Headwinds for banking sector – but not overly concerning
We have been more preoccupied with what the earnings and management commentary suggest about the state of the Canadian economy, its consumer, and overall credit conditions. Apart from one bank, most Canadian banks reported loan losses and provisions for future loan losses in line with expectations. There continues to be an uptick in credit card and auto loan delinquencies, and some banks flagged growing vulnerabilities among certain variable-rate mortgage holders. Overall, the Canadian consumer was characterized as reasonably healthy, with pockets of stress in certain areas. We would describe the credit environment as one that continues to gradually deteriorate, but not in a disorderly or concerning manner. While this represents a headwind to the banking sector, it has been anticipated for some time and is reflected in the sector’s below-average valuation.
Inflation down, economic growth modest
Elsewhere, recent Canadian economic data has not been overly surprising. Inflation continues its descent, with CPI for April down to 2.7% from 2.9% in March and 3.4% at the end of last year. Economic growth remains modest, largely driven by significant population growth from immigration. Closer examination of the growth numbers reveals that real GDP per capita has fallen over the past year and a half as businesses and households cut back on spending in response to higher borrowing costs. Both the manufacturing and services sectors have seen subdued activity over the past few quarters, with consumer demand weakening as budgets tighten and the labour market softens.
Relative strength of Canadian equities – and potential interest rate cuts
Yet, despite the soft economic backdrop and tight credit conditions facing Canadian businesses and households, Canadian equities have performed reasonably well year-to-date. This is partly due to growing conviction that inflation in Canada is on track to return to the 2-3% target range, raising expectations that the Bank of Canada might soon lower interest rates. A first cut is expected in either June or July. Additionally, strong performance across a range of commodities – including energy, copper, gold, uranium, and nickel, to name a few – has boosted the Materials and Energy sectors, which together account for close to 30% of the Canadian equity market.
Summary
Notwithstanding the gains made over the past year and a half, the valuation of the Canadian stock market sits just below its historical average. This seems reasonable given the challenging near-term domestic economic outlook. While sentiment may continue to improve with a further decline in inflation and the beginning of rate cuts, we believe a turn higher in the economic and earnings cycle may be required to drive a more prolonged period of stock price gains. Given the lagged effects stemming from changes to interest rates, we see this as more of a possibility beyond the next year.
What to consider for Capital Gains Inclusion increase – With Elvis Henrique
It can be easy to feel pressure to act in the face of the planned increase to the capital gains inclusion rate. However, it is important to keep a focus on your wealth plan, remove emotional decision making as much as possible, and not let the ‘tail wag the dog’.
While we continue to wait for confirmation of the plan and any formal direction on how the capital gains inclusion rate would be implemented, our in-house wealth planning specialist Elvis Henrique has summarized some important points to consider when evaluating your cash needs and how to approach the impending capital gains inclusion deadline. You can watch the video below, or read the summarized points:
#1 – Thing Big Picture
Tax deferral has and will continue to be a very important consideration when investing. Given the attention that the capital gains inclusion rate has received, it’s easy to feel pressure to make a move. However, it’s crucial that investors remain disciplined and focused on the larger picture.
Ask yourself: if there were no tax changes, what would you have done with your investments?
#2 – Further tax legislation is needed.
This is a case of “wait and see” – the budget documents indicated that there is more information and details to come, making it difficult to advise with so much grey area surrounding these new potential tax changes on many fronts at the moment.
#3 – Corporate transactions may create more urgency.
As the tax changes corporately will not have the first $250K threshold under the old rules, there might be more urgency in reviewing financial needs.
If you are anticipating needing funds in 2024 or in early 2025, there might be benefits to triggering any gains before June 25th. In a simplified example, the tax savings would be just over 8% (the difference in effective corporate capital gains tax rate at 50% inclusion versus the increased inclusion rate of 66.67% after June 25th).
#4 – Capital losses
If tax loss selling is something important to you, you may want to consider triggering losses after June 25th as that would yield a higher benefit if that’s your strategy.
#5 – Speak to your team of professionals.
Always, always speak to your accountant and/or tax advisor before acting – particularly on the corporate side of things. Everyone’s situation is unique, and you need to have professional advice on what makes the most sense for you.
Proof Point: Canadian inflation unlikely to pick up like in the U.S.
Canada and the U.S. have one of the closest bilateral economic relationships in the world after decades of collaboration and trade liberalization. Likewise, economic performance has generally been in sync between the two countries in the past because of their close relationship, along with inflation trends. But more recently, the Canadian economy has started to severely and persistently underperform.
In the latest Proof Point article, Claire Fan (an RBC economist) examines the reasons for the economic divergence, and why this might trigger differing monetary policy responses. You can read the whole article by clicking here.
Upcoming Summer Hours
A friendly reminder that Elinesky Schuett Private Wealth will be recognizing summer work hours. From this Friday June 7th to September 6th, our office will be closing at 4pm on Fridays. Thank you for your understanding.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
