This week the focus was on hotter than expected inflation results out of the U.S. Both CPI and PPI prints this week came in above estimates, with core CPI at 3.90% annually (expected was 3.70%) and core PPI at 0.50% MoM (expected was 0.15%) for the month of January. (BNN Bloomberg)  Despite the hype, it would appear that the broader disinflation them remains intact.  When looking at the stronger than expected Q4 earnings reports that have landed over the last several weeks, the results do not reflect a significant economic downturn is set to arrive in the U.S.

 

The other reason to expect this current rally in equities to maintain its strength is the fact there has been a significant outflow from Money Market Funds over the last eight-week period. Investors have been taking this short-term cash and allocating it to long term positions, both in fixed income and equities. This change in funds flow highlights two significant changes:

1. Investors who sat on the sidelines in 2023 with significant cash positions are now beginning to see the opportunity in the market, and

2. The prospect of interest rate cuts means that the historical high interest rates that have been offered by these Money Market Funds over the last 12-18 months is likely to decline as the Fed begins to cut.

As I mentioned in my note last week, for an investor focused on generating long-term passive income a sound strategy is to invest in long-term bonds that are still paying a historical higher coupon (interest) payment than they were over the last 15-year period prior to 2023. Yields remain elevated relative to last week, so there remains this opportunity and value in long term bonds from both an interest income perspective, as well as the potential for future capital gains in the next 1-2 years.

 

While we wait to see if the same narrative holds in Canada with January CPI results released next Tuesday, another key driver of growth and investor concerns remains our housing market. My colleagues at RBC Economics this week wrote a very detailed piece on the fact the that home prices have begun to tick up nationally after a considerable slump – you can read the article here: End of the correction? Canada’s housing market is warming up. It is worth noting that this increase has not been widespread and has been the story with our real estate market since the early 2010s the uptick in resales, new listings and positive price changes remain isolated to Toronto, Montreal, and Vancouver.

 

Another concerning factor here is that despite a higher interest rate environment, housing prices have room to rise – now whether this is on the back of expectations that rate cuts are coming or Canadians have become accustomed to the rate environment we are in remains to be seen. Regardless, there is substantial pent-up demand as a lack of affordability and scarcity of listings has driven most Canadians out of the market. Moreover, real interest rate relief will not be coming until at least 2025 when rates have declined meaningfully, as it is expected that we will see 100-125 basis points in cuts from the Bank of Canada this year.

 

There is a different story unfolding in Europe with respects to interest rates, as both the head of the Banque de France and Malta’s central bank head stated that the ECB should be considering a rate cut in March. (BNN Bloomberg) This comes off the back of a continued decline in inflation in January for the Eurozone, with January core CPI coming in at 2.8% (down 0.1% from December).  Unlike the experience in North America with the uptick in inflation we have seen in recent months, the trend downward for the Eurozone continues to be maintained. Moreover, there has been increased investor sentiment in the region, exemplified by Goldman Sachs this week upgrading its estimate for the Stoxx Europe 600 Index to end the year at 510 from 500 – citing improving economic activity, potential rate cuts and continued attractive valuations. (Reuters)

 

Finally, in China there continues to be a rout in mainland equity markets and the government is still trying to manage a real estate crisis that has put its economic growth in jeopardy long term. Many of the steps taken thus far appear to have two goals in mind: (1) instill confidence in the Chinese real estate market and (2) reduce the tendency for Chinese investors to focus on real estate as a growth asset in their portfolio of investments. Despite the continued stress on the economy, with the Lunar New Year arriving this week, consumer spending in the country appears to be picking up – which ideally should reflect in improved consumer sentiment. (BNN Bloomberg)  Frankly this is a seasonal change and it is questionable if this trend will maintain momentum past the holiday season, however it’s welcome news for the Chinese government as the manage several going concerns while aiming to achieve an average growth rate in 2024 of at least 5%.