Making public market predictions is a bit of a mug’s game. Any market/economic prediction is, at best, a guess (note that we did not even say educated guess here), yet investors’ inboxes are still being filled with predictions for the next year.

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Big interest rate declines, strong bank stocks and more market predictions for the year ahead Back to video

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We try not to make predictions, since public predictions in the internet age are going to be out there forever, and we don’t want to become a meme for having a prediction that is so wildly off it is funny. But investors seem to like them — and our editor told us to make some — so here we go (under protest).

Interest rates will fall faster and sooner

I don’t often agree with my fellow columnist David Rosenberg, but this time we do. He recently argued that rates are going to drop, and drop fast. Most economists, conversely, believe rates will take a much slower approach downward. We think Rosenberg has nailed this one: Inflation is all but disappearing in Canada, and interest rates themselves (through mortgage interest costs) are one of the key components of inflation.

As rates fall, even a bit, there is a corresponding decrease in inflation. This could set up a virtuous cycle of declining inflation and declining rates. This, combined with weak economic growth in Canada (see below) could mean big declines in interest rates in this country. If we are right on this call, it will also mean a lower Canadian dollar.

Earnings will be stronger than expected

Corporate earnings declined for three consecutive quarters starting in late 2022 and continued earlier this year. Then, for the third quarter, growth nicely resumed once again.

To understand this, put yourself in the shoes of a business owner. You were worried all year about higher inflation and higher interest rates, and you couldn’t open your inbox without seeing doom-and-gloom calls about a recession. What do you do in such a scenario? Well, you hunker down. Do some cost cutting. Improve productivity. Stop hiring new workers. Essentially, you prepare for the economic storm that is brewing.

But then the storm doesn’t happen. Customers continue to buy. Yet now you have a lower cost base. Profit margins have improved. Better cost controls, combined with technological gains (see our fourth prediction below) have resulted in better-than-expected growth in corporate margins and earnings. This will likely continue for some time, as lower rates improve confidence and get customers to spend even more.

Canadian market will lag — again

I don’t want to get political here, but the climate for business in Canada is just not as good as that in the United States. Just take a look at the recent moves regarding capital losses. Having to potentially pay taxes after losing money on stock trades (under a new proposal being discussed) is hardly any way to encourage investment.

But it is simply our economy that makes this prediction easier. Canada is scraping along at barely 0.5 per cent growth in gross domestic product. Without immigration, we would be in recession already. Meanwhile, the U.S. is chugging along at five per cent growth. Markets tend to follow the economy, so this is one of our easier calls (of course, as such, it will likely be the one that is the most off come next year).

AI will still be a thing

A lot of pundits are calling the huge boom in artificial intelligence a bubble. But we disagree. Unlike many bubbles, AI has the potential — already being noticed — of driving corporate costs lower. Lots of money is being thrown at the sector because companies have to stay relevant. If a competitor uses AI, they will likely get an edge in data mining, efficiency, production and customer happiness.

Companies could be left behind and need to at least look at AI and how it might improve their business. There is too much at stake here, and we understand the investor excitement for the AI sector. One noted analyst said that “every company in the world is going to need to use AI.” Growth investors should take note: this trend could last a while.

Financial sector will be a big winner

Over the past two years, investors have fretted over higher interest rates, higher inflation and the looming recession. Bank loan-loss provisions have increased, and bank stocks have been — until very recently — big laggards in the market. Valuations dropped to very low levels versus historical averages, and yields rose. For example, Bank of Nova Scotia shares recently yielded more than seven per cent.

But the largest Canadian banks have not cut dividends since the Second World War (National Bank of Canada did in the early 1990s, and Laurentian Bank of Canada cut during the COVID-19 pandemic). As rates decline, bank dividends will start to look more and more attractive to income investors.

In addition, while we don’t expect booming Canadian economic growth, we hardly think there is going to be a serious recession. Some of the loan-loss provisions the banks are taking now could be reversed in the future when things don’t turn out so bad. This could be very good for bank stocks.

Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)

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