Good afternoon,

 

And there went May.

 

I don’t usually pass along our canned plain-text letters, but today I thought I’d give readers a sample of one of our weekly print bits. It’s a more corporatey, technical read, but feel free to let me know if you’d like to see more like this, or if the lack of Mark’s snark ruined your weekend.

 

Mark

 

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.

 

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.

 

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.

 

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.

 

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.

 

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.

Should you have any questions, feel free to reach out.

 

Next, this week’s Global Insights newsletter.

 

State of play

More-demanding valuations across financial assets appear to signal investors have become more confident that a “soft landing” is the most probable outcome over the next 12 months. We provide an update on the macro environment and its implications for portfolios.

 

Regional developments: Bank of Canada expected to cut rates next week; U.S. homebuying sentiment at lowest level in nearly half a century; Stage seems set for the European Central Bank’s first interest rate cut; New support for Chinese real estate sector and more likely to come

 

Full read here: Global Insight Weekly.

 

Lastly, an update from our Economist, covering several issues:

• Easing inflation
• Central banks
• Economic convergence
• U.S. is OK
• U.S. consumer
• China’s true growth
• Chinese housing stimulus
• Japan 1.00%
• Canada capital gains

Read here: - https://www.rbcgam.com/en/ca/article/macromemo-may-28-june-10-2024/detail?utm_medium=email

 

Enjoy your weekend!

 

Mark