A lot of the outlooks Canadians read are about stocks down south, many focused on whether the bulk of them will catch up to the Magnificent Seven megacaps that have pretty much taken over the market, much to conservative investors’ chagrin.

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Rate cuts are coming, but Canadian investors should also be eyeing banks and oil Back to video

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Few focus on Canadian stocks and you can’t blame them. There are no sexy Big Tech-type stocks here, and the ones the Toronto Stock Exchange has had in the past flamed out in spectacular fashion: Nortel Networks Corp., Valeant Pharmaceuticals International Inc. and BlackBerry Ltd. pop to mind.

But even as the S&P/TSX composite index fades in importance on the global stage, much like the FTSE 100 in London, it still makes up a significant chunk of Canadian investing portfolios. Even if you actively avoid it, some of your retirement money is attached to the index given pension plans and other institutional investors own a bit of it.

Stock-market predictions, however, are notoriously poor, even in the short term. With that in mind, sticking to money managers’ thoughts, not numbers, is the better way to think about the coming year and there are some notable headwinds and tailwinds to keep in mind. Aside from whether inflation truly is dropping and central banks will begin cutting rates soon, and investors may be spending a bit too much time parsing out policymaker statements on that one, the fear of missing out (FOMO) could add some further fuel to equities.

“Investor greed, and blind faith could continue to melt markets up further even from here,” David MacNicol and Ken Reid at MacNicol & Associates Asset Management Inc. said via email. “We also believe there could be a catapultian effect in equity markets, when the money sitting in cash, equivalents, GICs, and T-bills re-enters the market, since many are being hesitant to go all in on equity markets after being blown out of the water in 2022.”

Another bullish cue is that the S&P/TSX composite had a relatively restrained rebound in 2023 compared to other markets, so it has already factored in some potential recession risks.

“Given that projections for 2024 now show lower recession risks, the TSX trading below its long-term average provides a decent margin of safety for investors,” Andrew Feindel, portfolio manager and investment adviser for Richie-Feindel Wealth Management at Richardson Wealth Ltd., said. “Additionally, the TSX’s attractive dividend yield also provides a performance buffer against potential challenges.”

Canada’s economic struggles are well-known, but collectively, the global economy continues to lose momentum, increasing the risk of recessions, leaving Canadian investors particularly susceptible because of the TSX’s sensitivity to the global economy, which is why Feindel prefers a defensive approach.

The silver lining of the current Canadian market, he said, is the array of sectors available at discounted prices: banks, real estate, utilities, pipelines and telecoms are all, to varying degrees, trading at low valuations that could mark good buying opportunities.

“While you could buy the whole discount bin, echoing John Bogle’s words of ‘Don’t look for the needle in the haystack, just buy the haystack,’ we prefer sectors that are less sensitive to economic conditions,” he said. “All have already partially benefited from yields coming back down, but a recession could weigh more heavily on banks and real estate.”

Feindel said the banks are trading at significantly discounted valuations from price-to-book and price-to-earnings perspectives, so there’s an opportunity to get in at a lower price if you’re a longer-term investor. Nevertheless, he currently prefers utilities and telecoms, noting the latter are benefiting from the record high number of new immigrants, and will likely benefit from lower rates in 2024 since they carry a lot of debt. For example, Rogers Communications Inc. has the sixth-largest corporate debt in Canada, according to FP Data Group.

Mike Archibald, a vice-president and portfolio manager at AGF Investments Inc., also said financials is a sector to watch. It had a tough 2023 given that rising rates created a weaker consumer, slower loan growth and elevated expenses, and the sector may not be out of the woods if the economy weakens in the first half. But he said the market will start to look through those challenges and begin allocating more capital to this space.

“Bank valuations are now below long-term averages and even with a challenging backdrop, all the major Canadian lenders are very well-capitalized to withstand any potential economic softness,” he said. “Once interest rates begin to move lower, lending should start to improve and interest in the sector will pick up once again as a good early economically sensitive group with a high correlation to improving economic conditions.”

Archibald is also looking at technology, something the S&P/TSX composite seems to lack compared to the S&P 500 and particularly the Nasdaq. But he points out technology companies still make up around nine per cent of the composite and he sees upside for this group during at least the first half of the year.

But Canada’s tech stocks have soared about 70 per cent this year, led by triple-digit gains by Celestica Inc. and Shopify Inc., topping the gains by their peers in the S&P 500 and the Nasdaq 100, which were less than 60 per cent. Indeed, the S&P/TSX composite had “the best performance globally among technology peers,” according to CIBC World Markets.

“Expected growth rates for technology far outpace most other industries, balance sheets remain strong and in an environment of weaker overall economic growth, higher-growth companies should still be preferred,” Archibald said.

Of course, tech companies of all stripes are trading at higher multiples because of the interest in them, making them more expensive to get into, so value-oriented investors might want to also take a look at the energy sector since the Canadian market is strong in fossil fuels.

MacNicol and Reid said oil companies have come out on the other side of a decade of consolidation driven by bankruptcies and low prices with clean balance sheets, strong cash flows and positive earnings. And, despite the green shift, fossil fuels will still be relevant for quite a while.

“We think moving forward, oil prices will remain in an area that will make energy companies highly profitable for time to come,” they said. “Oil companies are also trading at extremely low valuations relative to other sectors and their historical averages.”

As for natural gas, there’s a bit of a supply glut due to the mild fall and start to winter. But they said the market could soon be undersupplied as capital investment decreases, government regulation increases and the reliance on renewable technology rises.

“That’s something to watch moving forward,” MacNicol and Reid said. “Watch the physical market.”

The physical market for consumer goods, however, is one of the bigger challenges facing the Canadian economy, especially if pending mortgage renewals are at significantly higher rates than in previous cycles. Debt-to-income levels in Canada remain elevated and limit the future growth potential of the economy.

“The susceptibility of the Canadian economy to a recession remains significantly higher than in the U.S., where consumer balance sheets are much healthier and housing concerns are not as prevalent with 30-year mortgage rates and far fewer annual renewals,” Archibald said.

You might expect the federal government to step in if things get too dire, but deficits remain large and the debt is skyrocketing with no signs of any let-up in the near term, which Archibald said may hurt the government’s ability to aggressively stimulate the economy.

The major tailwind all the money managers are paying attention to is the trajectory of interest rates and the timing around potential rate cuts. Inflation is dropping, or stalling at worst, so the Bank of Canada’s focus on increasing rates to fend off rising prices has done the job. Easier financial conditions as rates drop should be a major driver for the stock market and help stabilize the stalled Canadian economy, the managers say.

The United States Federal Reserve has indicated three rate cuts are in the cards for 2024 — investors are pricing in six of them — but the Bank of Canada has resisted making any such calls, even saying it’s too early to tell if it will cut at all. As Archibald points out, the economy may need to soften further in the first half of the year to spur the central bank into action, which would likely result in pressure on the stock market ahead of the first set of rate cuts.

“The jury is still out on whether the Canadian economy can experience a soft landing, in which case, rates may ease gradually and overall returns would be more robust,” he said.

Sticky food and housing inflation could also indicate the higher-for-longer playbook will come into play here, say MacNicol and Reid.

“We also believe that if energy prices once again move higher, inflation will increase creating a second wave, similar to what we saw in the 1970s,” they said, referring to a period from late 1972 until the early 1980s that was marked by massive government spending, though rising oil prices played a role. The result was double-digit inflation and mortgage rates and a recession, which is still a threat today despite the soft-landing narratives.

“We believe a looming recession could come forth in 2024 in both Canada and the U.S.,” MacNicol and Reid said. “Corporate profits have decreased, which has lowered hiring and business investment. The GDP growth rate in Canada for Q3 turned negative as consumers hit the brakes on spending as they stomach higher prices and a higher interest rate environment.”

There is optimism the central banks are at the very least finished raising rates, so peak yields are behind us, Feindel said. But he also cautioned investors to remember the recession that happened after inflation dropped to less than three per cent in 1980 from eight per cent in 1976, though not all markets will experience the same level of fallout.

“The potential for global economies to be less synchronized could also be a significant tailwind as the potential slowing of the U.S. economy can be balanced with recoveries in Europe and emerging markets, which would benefit the TSX,” Feindel said. “Monitoring global trade and manufacturing indicators for signs of stabilization and improvement will be critical because a positive shift in these indicators would be a significant boon for Canada.’

Some, such as economist David Rosenberg, believe inflation is yesterday’s news. The Canadian consumer price index came in at 3.1 per cent in November on a year-over-year basis, the same as in October, but he said the momentum toward ever-lower underlying inflation measures continues unabated, especially when you exclude mortgage interest — something the Bank of Canada holds the key to. Excluding that factor, inflation was at 0.7 per cent, a figure last seen around the peak of the pandemic/lockdown recession in May 2020.

In the U.S., the year-over-year inflation figure for November dropped to 2.6 per cent and is trending towards the Fed’s target of two per cent. A year ago, the headline inflation rate was running at 5.9 per cent.

“As ‘Dandy’ Don Meredith would have said if this was Monday Night Football back in the 1970s, ‘Turn out the lights, the party’s over, they say that all good things must end!’” Rosenberg said.

• Email: aholloway@postmedia.com

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