January 15, 2024

Financial letter, Winter 2024, 66^th edition

Resisting the appeal of pessimism

The year 2023 started off with concerns about the impact of monetary policy tightening on economies worldwide. Impacts on GDP varied a lot. Defying expectations, the US economy managed to post higher than potential growth, while inflation cooled. Meanwhile, the Canadian economy was able to avoid a technical recession mid-year, but the situation would have been different if the country's population hadn't increased at a record pace.

Index		Level	3 months	6 months	1 year
S&P/TSX		20,958.44	8.11%	5.73%	11.83%
S&P 500 (USD)		4,769.83	11.68%	8.02%	26.26%
MSCI Emerging Markets (USD)		1,023.74	7.84%	4.81%	10.12%
MSCI World (USD)		3,169.18	11.53%	7.80%	24.44%
CAD/USD Exchange Rate		$0.76	$0.74	$0.76	2.34%
FTSE TMX Short-Term		769.76	4.11%	3.98%	5.02%
FTSE TMX Mid-Term		1,230.67	8.26%	4.20%	6.13%
Oil (US$)		$7.65	$90.79	$70.64	-10.73%
Gold (US$))		$2,062.98	$1,848.63	$1,919.35	13.10%

The good news is that excess inflation is easing. The imbalance between supply and demand is on the wane in many countries, excess labour demand has been largely met, and monetary policy continues to have a lagged effect. The spring of 2024 will mark the second anniversary of rate hikes in North America, suggesting that the impact of tightening will be felt throughout the year.

Contending with 2% inflation will still be a long and arduous process due to wage growth and, in some cases, like in Canada, the significant housing shortage will impact price growth for this component. However, the steady progress made should give the central banks enough confidence to start loosening their monetary policy.

The bad news is that the situation will continue to be painful for consumers and businesses. We expect Canada's economy will be flat in 2024. The stagnation in consumer spending for much of 2023 was due to several factors, such as the need for mortgage holders to save more for renewals. Since around half of all borrowers have not renewed their mortgage yet, these pressures will still be there in 2024. Businesses are starting the new year with significant concern as demand softens and payroll costs continue to rise. As is often the case in these phases of the economic cycle, business investment will suffer.

ASSET ALLOCATION

Following the concerted efforts by monetary authorities to curb inflation, the effects of rate hikes have yet to fully play out. The good news is that most economies are responding with tangible decelerations. If the economy had shrugged off the hikes announced up to now, central banks might have had to announce further rate hikes and maintain them for longer. This will probably not be necessary.

Investing in the face of an economic slowdown requires a certain amount of caution in the short term. However, the new year should also bring its share of opportunities! In short, we're taking a cautious positioning for the near term so we can seize opportunities as they arise.

We are therefore recommending a neutral position on cash, an underweight position in equities and an overweight position in bonds.

It's important to note that not only is the balanced portfolio (50–50) up just over 10% (before fees) in 2023, its ability to generate robust returns under different economic scenarios is also well established. This lets us enter 2024 with a healthy dose of confidence. If the economy dips more than expected, or stock markets see significant fluctuations, our bond exposure should at least be able to partially offset these pressures.

FIXED INCOME | OVERWEIGHT

Following 3 difficult years, the bond market is becoming attractive again. With inflation expected to continue trending down, economies slowing–or in some cases, even tipping into recession–the opportunity to add bonds is still worth considering.

The fight against inflation has since helped restore current bond yields to levels that haven't been seen in the past 15 years.

Moreover, the protection potential of bonds has also been restored.

We're maintaining our recommendation for an overweight position in government bonds as a refuge in the event of a recession.

EQUITIES | UNDERWEIGHT

THE CHALLENGE OF VALUATIONS

The US market has left little doubt as to its leadership in 2023. The S&P 500 is trading at a premium over most foreign stock exchanges, due to two key factors: superior tech components and greater domestic economic resilience. US market valuations appear to be one of the biggest challenges for 2024–meaning that valuations are high compared to the historical average.

CONCLUSION

The most significant factor at the year's end is the Fed's major policy change decided at its last meeting. This will see us move away from interest rate hikes and start looking at potential rate reductions. This announcement has given an extra boost to equities, while bond yields and mortgage rates have dropped. That's very good news.

Economic growth has proven robust and consumer spending has not collapsed, even though people have exhausted all or part of their pandemic savings and interest rates increased much more this year.

Given these rapidly changing market conditions, it's clear why the S&P 500 is just a hair away from its record close in January 2022. It's almost completely recovered from a disappointing 2022, and the March 2023 US regional banking crisis is largely a thing of the past! The gains were spread across the large businesses that have been the driving force behind most of the recovery.

More food for thought. All of these positive aspects could become causes for concern. The Fed has announced a change in direction–but that's not a promise. European central banks are still hiking rates, even if their economies seem a lot weaker.

The big risk for 2024 is that all of the good news has already been factored into the stock markets. Surprises are more likely to be negative than positive.

In the end, adopting a cautious positioning would seem to be the right approach, even if the momentum continues to push the markets to new heights.

Ultimately, given the challenges facing investors, it's important to:

Resist the appeal of pessimism. Pessimism always sounds smarter than optimism, says Morgan Housel*, because optimism sounds like a sales pitch while pessimism sounds like someone trying to help you. Pessimists seem to be preparing for the worse, that they're being prudent and acting as good stewards. But on average, optimists usually make more money over the long term. It's not a matter of being one or the other, it's about creating a plan and sticking to it!

We hope that this information helps you better understand the markets. Please don't hesitate to contact us if you'd like to discuss our investment strategies in more detail. We're committed to working ever harder to identify promising market opportunities to help you reach your long-term goals.

*Ref : Morgan Housel, La psychologie de l’argent