Taking Temperature of the economies on both sides of the border
The central bank rate cutting cycle is now underway, sparking a more cheerful tone in markets as lower interest rates and the prospects of future interest rate cuts will help to ease financial conditions and stimulate economic growth. One of the leading economic indicators as measured by the Citigroup Economic Surprise Index has pivoted to positive surprises. The U.S. job numbers for September were also stronger than expected. Both the payrolls and household survey suggested an acceleration in hiring in recent months. In the fall of 2024, the U.S. economy looks to remain on a soft-landing path.
Economic surprises have started to rebound
As of 10/03/2024. Sources: Citigroup, Bloomberg, RBC GAM
As with the U.S., Canada’s job numbers managed to deliver positive surprises. The rate of hiring has picked up over the past few months. Canada’s latest quarterly Business Outlook Survey showed continued subdued demand, but with an upward tilt in economic activity and a downward tilt in inflation pressures. Both are welcome.
While both economies are seeing positive momentum and lower inflation, there is a growing gap between the two countries’ GDP growth as measured by GDP per capita (per person). Given the diverging path in growth between the two countries, RBC Economics has forecasted a more aggressive rate cutting cycle in Canada vs. the U.S. and that has been reflected in both the pace of the interest rat cuts as well as the magnitudes. If the forecasted interest rate paths prove to be accurate, the growing gap in the benchmark interest rates between the two countries can put further pressure on the Canadian dollar.
RBC Economics’ U.S. and Canadian Overnight Rate Projections
Source: RBC Economics, Bloomberg
With the increasing soft-landing narrative, is Recession no longer a concern?
So far central banks have been able to bring down inflation without causing significant harm to the labour market and economic growth. However, there is a significant lag between when the recession starts and the first Fed rate hike. It takes on average 27 months for the impact of higher interest rates to work into the economy itself. Historically, most interest rate easing cycles have been associated with a recession or an approaching recession with exceptions in 1984, 1995 and 1998. Given that consumer spending accounts for approximately 70% of the U.S. economy, it will be crucial for us to see unemployment rates stabilize near current level and do not further deteriorate.
Source: RBC GAM, Federal Reserve, NBER, Bloomberg.
S&P500 Earnings Update for Third Quarter 2024
The third quarter earning season so far has been slightly disappointing with lower beats and lower earning revisions. Of the 37% of S&P 500 companies that have reported already, 75% have exceeded analysts’ EPS estimates. This beat rate is slightly below the five-year average of 77% but matches the 10-year average. However, the margin of these earnings beats has underwhelmed, averaging just 5.7% above estimates compared to the five-year average of 8.5% or a 10-year average of 6.8%.
At this stage of the earnings season, the blended earnings growth rate, which includes both reported and estimated results, stands at 3.6%. This would represent the fifth consecutive quarter of year-over-year earnings growth for the index but also the lowest growth rate since Q2 2023, when earnings declined by 4.2%.
Looking ahead, analysts expect a year-over-year earnings growth rate of 13.4% for Q4 2024. For 2024, the anticipated earnings growth rate is 9.3%. The forward 12-month Price to Earnings ratio is 21.7x, which is above the 5-year and 10-year averages of 19.6x and 18.1x, respectively.
Consensus S&P500 EPS growth forecasts have softend for both 2024 and 2025 recently
with Energy accounted for much of the downtick in 2024’s consensus EPS growth rate forecast
Source: RBC US Equity Strategy, Bloomberg. As of 10/25/2024
We have been talking to clients about gaining more exposure to the S&P Equal weighted index as opposed to the capital weighted index as the gap between the Magnificent 7 and the S&P500 excluding Magnificent 7 on an earnings per share basis is expected to narrow in 2024 and 2025. From a valuation stand point, the Price to Earnings ratio for the Equal Weighted Index is also less demanding in the context of a shrinking earnings growth gap.
S&P 500 Valuations continue to creep up, but remain a little below peak
Source RBC US Equity Straegy, Russell, S&P Capital IQ/ClarifFI, CIQ estimates, IBES estimates; as of 10/23/2024
Top 10 Valuations stalled near post-covid peaks, close to 19x in the rest of the index
Source RBC US Equity Straegy, Russell, S&P Capital IQ/ClarifFI, CIQ estimates, IBES estimates; as of 10/23/2024
U.S. Election Update
We tend to see an uptick in market volatility in the U.S. election year but there is also a tendency for US equities to rally post election other than in 2000 when the outcome was contested. Currently the market consensus sees a Republican sweep as the most bullish outcome while a Democratic sweep as the most bearish. The two most likely scenarios in the betting markets today are a Republican sweep and Democratic President/split Congress.
We have recently surveyed RBC U.S. based research analysts on their views of U.S. election’s impact on the sectors they cover. We try to dive in deeper on the specific policies announced so far, while keeping in mind it is early stage and difficult to accurately assess the potential impacts of policy ideas until the legislative process plays out and important details are determined.
US Summary: September 2024 RBC Equity Analyst Survey Results
What are the implications of different US election outcomes for your industry?
Source: RBC Equity Strategy, RBC Capital Markets
Canadian Summary: September 2024 RBC Equity Analyst Survey Results
What are the implications of different US election outcomes for your industry?
Source: RBC Equity Strategy, RBC Capital Markets
Within each sector, the policies that are considered most important are regulations, corporate taxes, tariffs, and trade. Foreign policy and immigration are the top issues within the electorate while regulatory and monetary policies are most top of mind for corporate executives.
Here is a summary on main themes on Tax and Regulation
Harris vs. Trump on Domestic Economic Policy – Corporate Taxes
Harris vs. Trump on Domestic Economic Policy - Regulation
Source: RBC US Equity Strategy; Harris Policy Book & Trump Speech columns only highlight information that was significantly incremental to comments made on the campaign website materials.
After Democratic Party nominee Kamala Harris built a small but tidy lead through September, the past few weeks have seen a significant reversal. Harris now slightly trails Trump according to the Predictlt betting market, and indeed quite a range of betting markets. Markets see a Republican sweep as the most favorable outcome as de-regulation and lower corporate taxes are seen as stimulative to the economy and can further fuel the animal spirit of investor sentiments.
For Canada, a more protectionist policy under Trump may hurt some of our industries and that is something we are on the look out for. Roughly 50% of the revenue of S&P/TSX 60 are derived from Canada, with more than 30% of the revenue derived from the U.S. and about 20% from the rest of the world. Most sectors, with the exception of Communication Services and Real Estate, have a high concentration of non-domestic revenues. Any significant changes in US policies, including trade and taxation, can have a direct impact on profitability and earning power of our large cap companies.
Lastly, it is worth reiterating there is no significant correlation between market performance and the dominance of a certain political party. There are often enough checks and balances in place that new legislations can only be introduced over time. Fundamentally, stock market performance is more a function of economic growth. The most important thing is to check your personal financial plan and make sure the investment strategies are aligned with helping you achieving your financial goals. Please don’t hesitate to reach out with any questions you may have both prior to and post the elections.
Rita Li works with professionals, business owners and high net worth families to provide tailored investment advice, risk management and financial planning. Her team comprises of professionals with in-depth taxation, insurance, and legal expertise; together, they deliver a high standard of service to clients. Rita is a Chartered Financial Analyst CFA® and Certified Financial Planner CFP®. Rita holds her MBA from Richard Ivey School of Business.