April 2024: Getting Closer to Rate Cuts
The first quarter of 2024 was much stronger than expected. We had anticipated that weak global growth and tight monetary policy would nudge Canada and the U.S. into mild recessions, but we actually saw much more resilient consumer spending and GDP growth. The S&P 500 and TSX Composite continued to run higher (+10.6 per cent and +6.6 per cent, respectively in local currency) following already dramatic increases in 4Q23. Enthusiasm for U.S. equities has remained high and broadened out slightly to include energy, financials, and industrials, but the positive earnings revisions so far have still been primarily in the A.I.-focused technology names. More broadly, profitability continues to be under pressure for most companies and sectors, although investors are starting to look for an overall improvement into 2025, hence the positive market outlook. In Canada, the best performing sectors have been energy, health care, and industrials. Despite a weaker growth outlook through the remainder of 2024, we continue to see optimism towards improvements in 2025.
We continue to expect policy rate cuts in the second half of 2024, potentially starting in June. As we started 2024, we saw the U.S. financial markets pricing in 6-7 rate cuts through the year. Just a few months later, with a resilient economy, still relatively strong labour market, and stubborn inflation, many forecasters are floating the possibility that the Federal Reserve (Fed) may not even cut rates at all this year. According to the dot plot, four out of the 19 Fed officials are also in the 0-1 cut camp, up from three officials in December. Our U.S. economics team still maintains that the Fed will cut three times in 2024, but it also has the potential to defer those cuts, given the still strong U.S. economy and low unemployment rate. We have also shifted our forecast from expecting the mildest recession in U.S. history to a soft landing scenario, with a slight uptick in our U.S. GDP forecast, from 1.7 per cent to 2.1 per cent. In Canada, we see more justification for rate cuts, with weaker economic growth than the U.S., a higher and increasing unemployment rate, and recently better inflation numbers.
Key Takeaways:
- U.S. Economy: Expectations have shifted from this being the mildest recession in U.S. history to a soft landing scenario. Continuing economic growth with still low unemployment has investors excited about improvements in earnings and broadening out of the markets, despite the potential for the Fed to further delay the start of interest rate cuts.
- Canadian Economy: Despite some better than expected results through the first half of 2024, the economy is likely to continue weakening through the remainder of the year, driven by tight monetary policy. Some sectors are benefiting from the strength in the U.S., and certain commodity prices, but still high rates have slowed the Canadian economy much more than the U.S. economy.
- Central Bank Decisions: Our U.S. economics team expects three rate cuts in 2024, starting as early as June, as GDP softens to just under 1 per cent growth in Q2 and Q3. Although this is much more modest than the consensus expectations of six rate cuts coming into the year, more market watchers now seem to be more conservative, increasing the possibility of fewer or even no cuts in 2024 as the Fed has the luxury of pushing out that decision given that the economy has not been overly strained so far, and as employment has remained resilient. In Canada, our fixed income team is similarly looking for three rate cuts before the end of the year, although the possibility of receiving fewer is rising quickly. Many Canadian market watchers seem hopeful of more cuts, and starting sooner rather than later.
- Canadian Equity Positioning: Our forecast for the S&P/TSX Composite in 2024 is 22,000, implying a total return, including dividends, of just over eight per cent from the beginning of the year, although we foresee increased volatility. Future returns are expected to be mainly driven by P/E expansion and dividend payments, as valuations tend to rise when investors anticipate a new business cycle. The anticipated lower interest rate in the second half of the year should also support higher equity valuations. On the other hand, EPS growth faces pressure from the economic slowdown. Sectors with higher exposure to the U.S. and/or ones that are less affected by a slowdown in discretionary spending, notably info tech, industrials, and consumer staples, are expected to outperform, while the energy sector continues to benefit from an increase in global oil demand.