We hope you are having a great start to Spring, and we are looking forward to some warmer weather ahead. We’ve included some information on the 2024 Federal Budget and a Market Update.
2024 Federal Budget Summary
The 2024 Federal Budget was released on April 16th, 2024. Here is a link to a 2024 Federal Budget article for a comprehensive summary. We’ve included a couple of highlights below.
One of the more material changes is a proposal to increase the capital gains inclusion rate from 50 percent to 66.67 percent for corporations and trusts. For individuals, the 50 percent capital gain inclusion rate will be used for the first $250,000. The 66.67 percent inclusion rate will be calculated on the portion of capital gains realized in the year that exceed $250,000. This will take effect on or after June 25, 2024.
The budget also proposes to increase the Home Buyers Plan (HBP) withdrawal limit from $35,000 to $60,000. The HBP helps eligible home buyers save for a downpayment by allowing them to withdraw funds from a registered retirement savings plan (RRSP) to purchase or build their first home, or a home for a specified disabled individual, without having to pay tax on the withdrawal. Couples purchasing a home jointly may therefore be able to withdraw up to $120,000 from their RRSPs to purchase a first home. Amounts withdrawn under the HBP must be repaid to an RRSP over a period not exceeding 15 years, starting the second year following the year in which a first withdrawal was made. The budget proposes to temporarily defer the start of the 15-year repayment period by an additional three years for participants making a first withdrawal between January 1, 2022, and December 31, 2025. Accordingly, the 15-year repayment period would start the fifth year following the year in which a first withdrawal was made. For a couple who withdrew the maximum in 2023, extending the grace period could allow them to defer annual repayments as large as $4,667 by an additional three years.
Market Update
With the exception of the past several days, when we saw escalation of the conflict in the middle east, Global equity markets have been somewhat directionless over the past few weeks, likely taking a breather after a reasonably good first quarter. Investors are digesting recent jobs reports in Canada and the U.S. Meanwhile, the consensus view remains that rate cuts are looming in the second half of the year though the exact timing and degree of cuts are topics of debate given recent comments from a few officials at the U.S. Federal Reserve. Both the Bank of Canada and the U.S. Federal Reserve have telegraphed the potential for rate cuts in 2024. Policymakers at the Bank of Canada recently indicated that cuts could be appropriate this year if the economy evolves in-line with current forecasts. The case for lower interest rates in Canada has become more convincing as recent economic data point towards moderating inflation. On the other hand, the argument for rate cuts seems less compelling in the U.S., given the economic strength that has been maintained amid higher rates. When speaking recently, Federal Reserve Chairman Jerome Powell signaled that first quarter inflation data has raised uncertainty over when and if lower interest rates would come later this year. This is a divergence from just a couple of weeks ago where Markets were expecting three cuts this year in both Canada and the U.S., with the first one occurring as early as June.
The key takeaway is that rate cuts are a real possibility in both Canada and the U.S., even if the rationale and extent of these policy moves might be debated based on the current state of the two economies. Historically speaking, an environment characterized by declining interest rates tends to be supportive for investment returns. The strong equity market performance in recent months may reflect some of this optimism, though we would not be surprised to see markets continue to push higher, at least until some future developments prompt a reassessment of the outlook for inflation, growth, and interest rates.
Given the strong global equity market gains over the past year, we discuss market valuations and return expectations going forward. We have and continue to be guided by a simple but intuitive framework for longer-term investing. In essence, it suggests that long-term returns can be particularly rewarding when investments are made at inexpensive valuations. Likewise, investing results have proven to be less satisfying, over time, when investments were made at elevated valuation levels. Importantly, this guideline has no real bearing on investment returns from one year to the next. Rather, it has proven particularly useful for investors to use this over longer time frames to help assess the long-term return potential of various asset classes. Reflecting on this basic rule recently has led to us to ask the question: where are valuations today? And importantly, what expectations should we have for longer-term returns from equities?
On the surface, the large cap U.S. stock market, as measured by the S&P 500 index, appears expensive. That’s not that surprising given how well it has performed since the lows reached in the fall of 2022. Its forward Price to Earnings ratio, which reflects the current price divided by the earnings expected from the companies within the index over the next twelve months, currently sits at about 21. That compares to its average of 16 over the past twenty to thirty years. But, as has been well documented in recent months, the gains of the U.S. market over the past year have been heavily influenced by the performance of the “Magnificent 7”, a group of seven large technology stocks. If we strip out these seven stocks, the market’s P/E ratio falls to a more reasonable range of 17-18. In other words, the U.S. market is not cheap but may not necessarily be as expensive as one would think.
A similar story exists elsewhere. The forward P/E ratio for the Canadian equity market is just below 15, which is around its long-term average. The same ratio for overseas developed markets is also just below 15, which is slightly higher than its long-term average. In emerging markets, the ratio is nearly 12 which is also just above its longer-term average.
The key takeaway is that despite the fact equity markets have done well since the lows reached in 2022, the valuation levels, outside of some of the largest technology stocks in the world, are not necessarily at the kind of elevated levels that would suggest investors need to meaningfully recalibrate their long-term return expectations. Nevertheless, should markets continue to march forward without a meaningful pick-up in earnings, we may have to revisit this exercise as it could be indicative that markets have pulled forward some of the future return potential from the asset class.
Should you have any questions, please feel free to reach out and please let us know of any anticipated cash needs you may have during the year.
Kothlow Unser Wealth Management Group
7th Floor - 2950 Glen Drive
Coquitlam, BC V3B 0J1
604-665-0740