Stock and bond markets have a bumpy year ahead of them but will end 2024 on a positive note as they navigate the last mile of inflation and tightened monetary policy, a new report from Edward Jones says. 

The investment firm’s prediction is based on three fundamentals that will favour markets this year: interest rate cuts from the Bank of Canada and U.S. Federal Reserve, continued easing inflation and growth returning in the second half of the year. 

"If we go back the last two months, we've seen a pretty strong rally in equities and that's really driven by expectations that the Fed and Bank of Canada rate cuts are not too far away," Angelo Kourkafas, senior investment strategist at Edward Jones, said in an interview. 

"We’ve seen a moderation in inflation and some rebound in corporate earnings, which support the favourable outlook even though we're not yet out of the woods. Still there are some downside pressures, especially for the Canadian economy," he said. 

Although the economy has likely avoided a worst-case scenario in terms of a downturn, he added.

The forecast comes after 2023 defied expectations that the economy would slip into a recession and markets outperformed many strategists’ predictions.

Investors are laser-focused on interest rate cuts this year, after the Bank of Canada lifted its benchmark rate to five per cent in its most aggressive hiking campaign ever to combat inflation. 

Statistics Canada said Tuesday the annual rate of inflation rose to 3.4 per cent in December, an acceleration from 3.1 per cent in November, but a significant improvement from the peak of 8.1 per cent in June 2022.

Bank of Canada governor Tiff Macklem has said repeatedly that the path back to the central bank's inflation target of two per cent wouldn’t be linear. 

Edward Jones said the core of its market outlook for stocks and bonds is the "notable shift" in monetary policy in 2024. 

Kourkafas sees three to five rate cuts from the Bank of Canada on the way this year.

Outside of an external geopolitical shock, rate cuts failing to materialize is one of the biggest risks to the market, he said, though he added that it wasn’t his base case scenario.

"The realistic estimate for the Bank of Canada is they could possibly lower their policy rate by one per cent, so let's say it goes from, you know, five to four per cent but that depends on the path of inflation and the economy," Kourkafas said. 

The report also predicts U.S. stocks will outperform Canadian equities.

Kourkafas said he thinks economic growth in Canada will continue to lag in the first half of the year as high borrowing costs weigh on indebted households and because the earnings outlook in the U.S. is better than in Canada. 

The report noted the U.S. presidential election later in the year will cause some volatility but it will be short-lived. 

This year will also likely see a rotation back into defensive stocks and cyclical sectors, which lagged over 2023, as megacap technology stocks dominated market gains, Kourkafas said. 

As fixed-income yields fall in tandem with interest rates, dividend stocks start to look more attractive, he said.

"So that rotation, we think is likely in its early innings, meaning we saw that in November and December, but we think there's a lot more to go even though there will be some volatility along the way," he said. 

This report by The Canadian Press was first published Jan. 16, 2024.