National Bank of Canada Financial Markets' Canadian ETF Flows aptly summarizes the year 2023 in financial markets. "Investors finally had a chance to catch their breath this year despite elevated volatility, ramping interest rates and stubborn inflation," lists the monthly bulletin dedicated to the evolution of exchange-traded fund (ETF) assets, in its January 3, 2024 edition.
National Bank of Canada Financial Markets reports that after the year 2022, which was “marked by historic drawdowns in both equity and fixed income, 2023 saw global equities recover and approach alltime highs.” ETFs reflected these trends, according to Canadian ETF Flows. For example, the market downturn in 2022 led to the first decline in ETF assets in 20 years.
Recovery followed in 2023. "In 2023, however, we saw a late-year, fast recovery in both equities and fixed income, coupled with a steady net annual inflow figure of $38.4 billion. Together, these forces brought ETF assets in Canada to the new historical high of $383 billion at the end of the year," it reads.
As barometers of the stock and fixed income markets, defined benefit pension plans ended 2023 in a better position than at the start of the year.
Aon's Pension Risk Tracker tool reveals that the overall funding ratio of Canadian plans associated with the S&P/TSX composite index increased to 101.8% on December 31, 2023, compared to 100.7% on December 31, 2022.
At Mercer, the median solvency degree of the plans in its database rose to 116% at the end of 2023, compared to 113% at the beginning of the year.
Risks and artificial intelligence
"Pension plans have been volatile over the past year," said Jason Malone, principal partner, wealth solutions, at Aon. Malone believes most plans in Canada ended the year in good enough shape to continue planning risk reduction activities. "Including annuity purchases and standby strategies like liability-driven investment and judicious use of diversified growth assets," he adds.
Mercer, for its part, notes that the recent improvements in solvency degrees of Canadian defined benefit (DB) pension plans come after many years of low interest rates.
"Members of Canadian DB pension plans and their sponsors will be keen to maintain solvency ratios above 100%," predicts Jared Mickall, Principal and leader of Mercer’s Wealth practice in Winnipeg.
"Canadian DB pension plans should continue to be vigilant in the financial management of their plans through appropriate governance and risk management processes. A consideration in 2024 will be the role of artificial intelligence as part of pension plan risk management," continues Mickall.
Malicious geopolitical actors
Concerns will change in 2024, according to a survey conducted between October and November 2023 by Natixis Investment Managers, with 500 institutional investors in 27 countries.
Sustainable growth, interest rates, and inflation will give way to geopolitical risk, reveals the report Brave New World: Geopolitical and economic uncertainty clouds 2024 outlook for institutional investors, by Natixis. The survey participants mentioned in this report are 49% to rank geopolitical risk among the main macroeconomic risks of 2024.
According to the sentiment of the surveyed investors, this risk resides in "geopolitical bad actors who with one action can upset economic and market assumptions globally." Natixis cites among other factors the Hamas terrorist attack against Israel, the protracted war in Ukraine, and Russia's dealings with Iran and North Korea for military assistance.
Raising rates: A mistake?
Two other main risks appear on investors' radar, according to the Natixis survey: a slowdown in consumer spending (for 48% of investors) and a central bank policy error in its monetary policy (for 42% of investors).
When the Bank of Canada (BoC) announced on December 6 that it was keeping its policy rate (overnight rate target) at 5%, its governor, Tiff Macklem, said he did not rule out a rate hike if needed.
A comment that created a divide with economists. Among them, the chief economist of the Order of Chartered Professional Accountants (CPA), David-Alexandre Brassard, reacted to Macklem's comment in an economic update. "I was surprised that the Bank of Canada remains ready to raise interest rates further. There are few or no signs that the Canadian economy needs it. If anything, most economists now expect rate cuts," he writes.
In its global macroeconomic outlook for 2024, Mackenzie Investments writes that the Bank of Canada "has likely finished raising its policy rate for this cycle." The fund manager bases this on the fact that the cumulative rate hikes are starting to take effect in the Canadian economy.
" While inflation is now well below its peak level, it remains above the BoC’s target," adds Mackenzie Investments in its overview. Interest rates seem, however, "at high enough levels to restrain interest-rate sensitive areas of the Canadian economy like real estate," the manager estimates.
Housing costs
Regarding the door left open for a policy rate hike, Brassard acknowledges that it is relevant for the Bank of Canada to consider housing costs as a driver of inflation. However, the chief economist of the CPA order questions the Bank's silence on the "counterproductive impacts" of high-interest rates on this component of inflation.
According to the Bank of Canada's data, inflation measured by the overall Consumer Price Index (CPI) stood at 3.1% in November 2023, the same level as in October. In September, inflation measured by the overall CPI was at 3.8%, far from the peak of 8.1% reached in June 2022.
The central bank's policy rate has remained at 5% since July 13, 2023. The July hike was the 10th since the Bank of Canada began its tightening on March 3, 2022. It had then raised the policy rate from 0.25% to 0.50%. The policy rate had been at the floor of 0.25% since March 27, 2020.
Still tech in 2024
According to responses to the Natixis survey, many institutional investors believe that the information technology sector will remain a growth driver in the stock markets. More than half (52%) of the surveyed investors expect this sector to outperform compared to the average of sectors in 2024.
Their concerns about a potential recession and high interest rates color their investment calls (calls) in other sectors in 2024. For example, only 17% believe that the consumer discretionary spending sector (non-essential goods and services) will outperform compared to the average.
Rotating recessions
In Market Outlook 2024, IG Wealth Management advises investors to follow sector fluctuations to see how markets can self-correct and continue to advance.
"The 'rolling recessions' currently taking place in economies around the world, including Canada, show that while some sectors thrive, others struggle. Despite this sector-to-sector uncertainty, at its core, we are seeing more evidence of global economic recovery than recession risk," said Philip Petursson, chief investment strategist at IG Wealth Management.
In its 2024 Market Outlook, IG points out that some sectors, like manufacturing and global trade, are reaching a trough but should recover in 2024. These rotating recessions testify to an economy's resilience.
During these economic phases, a rigorously followed long-term investment strategy promotes sustainable growth. Moreover, the risks of recession in the United States in 2024 have decreased, and a recovery seems more likely.
The Canadian economy seems more at risk of recession, given that interest rate hikes usually have a more immediate impact on consumption. However, as the Canadian stock market is more globally oriented, the TSX (S&P/TSX index) should benefit from a global economic recovery.
