Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about Canadian equities with Vim Thasan, vice-president of Canadian equities with Beutel Goodman Investment Counsel. We asked about opportunities and risks. And we started by asking how Canadian equities have fared so far this year.

Vim Thasan (VT): So, we started off 2023 on the back of a large drawdown, given growing fears of an economic recession. And that resulted in negative market returns in 2022. Then the sentiment shifted quickly in the new year, as the Canadian market rallied, and this was driven by a resilient consumer and expectations that rate cuts by the Bank of Canada would follow in 2023. Early in the second half of the year, that narrative changed with an expectation for higher-for-longer rates that could put pressure on the economy through tighter credit conditions for consumers and businesses. Now, if you look at the TSX composite index, you can see there’s a polarization in returns across companies and sectors. That impact of higher rates can be seen most in rate-sensitive sectors like communication services, real estate and utilities. And the overall fear of a recession in the economy is most material in banks and consumer discretionary stocks. In contrast, the best-performing sectors have been technology driven by Shopify, and energy driven by supply limitations and increasing geopolitical tension.

The ongoing recession watch

VT: The pendulum of macro predictions has been swinging back and forth from a soft landing to a hard landing, to no landing. We use these dislocations to act on individual opportunities. We’re not blind to the highly anticipated recession that’s being priced into sectors and stocks. There’s clearly evidence of a slowing economy and we can see this in retail sales at stores, freight volumes in rail, and loan growth at banks. The Bank of Canada’s most-recent survey of consumer expectations showed that high inflation and rising rates have had a negative financial impact on most households. It’s causing them to reduce spending, and we should also note that interest rate hikes may not be over. As core inflation remains some way off the central banks’ 2% target, both in Canada and the U.S., the central banks haven’t ruled out further rate hikes. Until fairly recently, many investors had expected rate cuts early next year. So, this hawkish tone by central banks has led to heightened volatility in both the equity and the bond markets. The likelihood of a soft landing or avoiding a recession altogether won’t improve if rates go up again.

Headwinds for Canadian stocks

VT: One key headwind to monitor is the health of the Canadian consumer. Consumer behaviour will be driven by employment, wage growth and affordability that’s hampered by inflationary and rate pressures. High household debt requires a higher payment as interest rates rise, creating refinancing challenges in mortgages. Couple this with concerns around the underlying value of homes, it means the Canadian consumer is in a weaker position than the American consumer right now. We believe the headwind is being reflected in the negative expectations for consumer discretionary and bank stocks.

Tailwinds for Canadian equities

VT: An important tailwind is the negativity and skepticism that’s being priced into some stocks. Earnings expectations have been revised lower. Forward guidance by management is muted. Assuming normalization over time, a wider discount to intrinsic value improves our risk-return profile for our portfolio. The key risk is time, which means the timing and severity of an economic slowdown and the subsequent recovery in business profitability is hard to predict. If we don’t have a recession, there’s an opportunity for positive earnings revisions and evaluations to rise. Another overarching tailwind is that we’re seeing slowing inflation, a slowing economy, and therefore a higher probability that we’ve hit peak rates this cycle. This would relieve some of the pressures we spoke about from tighter credit conditions and provides more clarity on the ceiling for rates. I think that is very relevant, and probably very pertinent as, you know, a tailwind to a Canadian investor.

And, finally, what’s the bottom line on investing in Canadian companies at the current moment

VT: Clearly, there is a heightened level of uncertainty and fear. And this is driven by a laundry list of concerns from inflation, central bank policy, the health of the consumer, credit concerns, China’s recovery, wars and [an] upcoming election. While the market is focused on timing a recession, we’re focused on finding attractively valued companies that are getting lost in the noise of macro predictions. We find that valuations are attractive in certain parts of the market This presents an opportunity for stock selection. So, we are finding great value in quality Canadian franchises, and we continue to be optimistic on the potential in the Canadian equity portfolio.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Vim Thasan of Beutel Goodman Investment Counsel. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.


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