Hello everyone. Welcome to Economic Impact. Today is September 10th,
2024 and as usual, I am with our Chief Economist, Stéfane Marion. Good
morning, Stéfane.
Good morning, Denis.
So, since the last time, we see the performance from the asset
classes being a bit different. Since the last time.
Since we last time we saw each other, was in July at the beginning
of Q3, right, all asset classes were rising. We were arguing for
potential volatility. And now near the end of Q3, we can see this
volatility has actually occurred, or more dispersion I should say with
respect to the total returns of different asset classes. Note that the
S&P TSX was really trailing behind all the other equity indices,
actually leading in the third quarter, but followed by the bond
market. And maybe the biggest difference, Denis, is the
underperformance or lack of performance, negative performance from the
S&P 500. So that's a big change from the start of the third quarter.
And because of that, we saw the volatility increasing quite a lot.
Well, yeah, you know, the negative return was triggered by a surge
in volatility in August. Note on this slide that if you exclude the
pandemic episode, we haven't seen volatility - VIX - at 40 since 2015.
So about a decade, 9 years. And that means Denis that people are now
second guessing what the actual outlook will be like. I would just
remind you that at this point in time, there's still 80% of investors
that are bidding on a soft economic soft landing for the US. We'll see
what happens. But clearly there are some investors saying, well, maybe
things are not so clear cut going forward.
Yeah. And I think the Fed not decreasing rates makes that volatility
is getting higher and higher because, you know, people are expecting
those rates going down and they're not coming down.
Yeah. Do you know how long it's been since the Fed last cut rates, Denis?
Long, long time.
Well, since their last rate hike, it's been now 12 months.
Historically, that's very, very long because on average, the Fed will
cut rate seven months after its last rate hike. Now it's been a year.
We're going to get one probably in September. But note on this slide,
what the big difference is between this time around and previous cycle
is that the unemployment rate is up almost a full percentage point.
Well, 0.7 percentage point, which is much bigger in terms of amplitude
than what you normally see in a typical cycle, which is the blue line
on this slide.
Is that what we call the SAHM rules?
If you want to speak to economics jargon on that one. OK, fine. I'll
summarize what the SAHM rule is. I'll simplify it. Normally when the
unemployment rate that rises 1/2 percentage point above its cyclical
low, you trigger what you call the SAHM rule. And historically it's
been associated with a significant slow down of the economy and more
often than not a recession. So the SAHM rule was actually triggered
last July, which brought this volatility that we got in August on the
stock market. Now, as I said before, most people still believe all the
SAHM rule is misleading us this time around. Maybe the soft landing is
still the typical outcome because even the Fed argues that they can
achieve a soft landing despite being very late in the game in terms of
cutting rates.
And despite the fact that about the Fed are not, you know, moving
down on their rates, global inflation is still creeping down.
Now, I will concede that the Fed is able to cut rates now and maybe
they will be able to cut rates aggressively because inflation is
coming down. As you can attest on this slide, you know, it's a global
phenomenon. It's not just a Fed that will be coming cutting rates.
It's a whole bunch of central banks. And under the circumstances, if
it's a synchronized easing cycle, people believe that, there you go,
you're going to get this economic soft landing and earnings won't be
impacted negatively.
And at the same time, you know, we're seeing the economy cooling.
That means that, you know, earnings and revision may come.
Inflation does not come down by magic, Denis. So basically, what
that means is that for inflation to come down, you have to get slower
economic growth. And if you get slower economic growth and you keep
monetary policy restrictive, you can get an accident. You know, at
some point in time, as you'll see on this slide, the blue line shows
that global manufacturing activity is now contracting again. And
historically this has been associated with downward earnings revision.
So again, the market is priced for perfection right now because you're
training at high multiples and the assumption is that, you know,
mission accomplished by the central banks, you'll get this economic
soft landing and no impact on earnings. But I think an impact, a
negative impact is coming if you can gauge on historical relationship
between activity and earnings revision.
But then earning growth expectation will have to come down because
right now they are still pretty high.
Yeah. And remember we spoke to this back in July and say, listen,
this is a bit high. It was expectations of 14% over the next 12
months. It's been revised a little bit down, but you're still
expecting 12%. That's the red zone or pink zone on this slide. 12%,
you know earnings per share growth globally, but note that every
region in the world is showing a positive uptrend on earnings despite
the fact that monetary policy remains restrictive. So we're going to
get these rate cuts Denis, but monetary policy is not becoming
accommodative anytime soon. So you're going to get below potential
growth, which I think will impact earnings.
More to come then on that front.
I think so, yeah.
OK. If we come back to Canada, then you know, GDP still pretty high,
but consumption, personal consumption are not there.
Yeah. So, if you focus of course on GDP, you'll say, ah, it was a
better outcome than expected, but that's because government accounted
for 50% of growth in the second quarter. If you look at consumer
spending, the red line on this slide is pretty anemic, Denis. So, and
that's impressive when you consider that population growth continues
to surge in 2024. So to get the surge in population growth, this and
only 0.6% growth in consumption means that your economy is not
performing very well. So things are not better than elsewhere in
Canada. It's actually it's a pretty tame GDP outcome in Q2.
Would you say that at this time, even if the Bank of Canada lowers
rate, you know, before the Fed, they're not lowering fast enough to
bring the consumption back?
It's a good question. I mean, the reason consumer spending is so
weak is because households must devote 25% of wage increases to
servicing their debt because interest rates are much higher than they
were a few years ago. So considering all that, considering that
inflation's coming down, there's going to be rate cuts. But at the end
of the day, what you can see on this slide is that despite the fact
that the Bank of Canada has cut rates already twice, the policy rate
adjusted for inflation is barely coming down. So, monetary policy
remains the most restrictive since 2006. Denis, what that means is
expect slower growth in Canada and a higher unemployment rate, which
will probably lead the Bank of Canada to accelerate the pace of rate
cuts in the coming weeks. So yes, there will be collateral damage to
the Canadian economy in the coming weeks. So but the good news,
inflation is coming down. They can cut down to cut the rates
aggressively, but there's still going to be an impact on earnings in
Canada as there will be a negative impact elsewhere in the world.
Would you say that the Bank of Canada don't cut rate as much as they
should because of the Fed not starting to do so?
You're right that they were probably a little bit shy of going more
aggressively, but probably concerns about the Canadian dollar. But at
this point in time, you know U.S. dollar has been weak. So Canadian
dollar as hell is ground. So I think that opens the door for more
aggressive rate cuts in Canada. Actually, our fixed income strategist
who recently published their monthly and we're showing an acceleration
of the pace of rate cuts from the Canadian perspective in the months ahead.
OK, now we said all of that. What do you expect has returned from
different asset classes.
Investment conclusion, right. So well, Denis, if you trigger the
SAHM rule, I'm sorry, historically it's not good for risk assets. So,
historically 3 months following the triggering of the SAHM rule and
note that this is one of the first time the Fed has not even cut rates
despite the triggering of the Fed SAHM rule. You can see that the
stock market whether it's the US or Canada, it's down about 9%. The
only asset classes that play a defensive role would be gold prices and
the US dollar. Gold because more volatility, the US dollar because
more risk off environment and clearly the bond market is also
somewhere to hide. So investment conclusion, Denis, I think there's
going to be more volatility this fall as people reassess their
earnings expectation. So it's time to be play a bit more defensive in
our opinion. And just those US elections coming up, most uncertainty
about policies, keep that in mind also.
Well, thank you, Stéfane, and thank you for being with us today. And
above all, we expect to be with you next month, beginning of October.
Have a good day. Thank you.
