As early as July 2023, Sébastien McMahon, Chief Strategist and Senior Economist at iA Financial Group, expressed a constructive yet cautious outlook. In an interview with Insurance Portal on November 10, he reaffirmed this stance. "Our positioning remains very neutral," McMahon revealed.
The economist explains why he's tempering his optimism: "The signals are currently challenging to interpret and contradict the macroeconomic perspective. We are in a waiting mode; we're waiting for more clarity before making a decision," he adds.
However, McMahon identifies early signs of a recession. "Historically, the quarters preceding a recession show a positive trend. Currently, people hear in the news that the interest rate hike is over, that nothing is broken in the economy, and that it will land smoothly, but there will be a slowdown. Factors could delay it further in the United States. In Canada, we are already experiencing it," says McMahon.
The Economy slows down
In Quebec as well. During its economic update on November 7, 2023, Quebec Finance Minister Éric Girard revised downward his growth projections for 2024. Persistent inflation and a prolonged rise in interest rates will curb economic activity in 2024. "As a result, economic activity is expected to grow by 0.7%, compared to the 1.4% increase forecast last March," Girard said. He predicts that Quebec's real gross domestic product (GDP) is set to rise by 0.6% in 2023. In 2022, Quebec's real GDP grew by 2.6% compared to 2021.
In its 2023 Fall Economic Statement, the Government of Canada says a GDP's "growth of 0.4% is expected for 2024, compared to the 1.5% projected in Budget 2023." According to the latest data from Statistics Canada, the GDP growth rate, at basic prices for all industries, reached 0.9% in August 2023 compared to August 2022. In comparison, the Canadian GDP grew by 3.9% between August 2022 and August 2021.
The Bank of Canada's survey of about 30 market participants, the Market Participants Survey - Third Quarter 2023, does not suggest a significant improvement in 2024. According to the median of the responses in the Canadian central bank's survey, GDP is expected to grow by 1.0% in 2023 compared to 2022. The most optimistic scenario (75th percentile of responses) stands at 1.1%, and the most pessimistic (25th percentile of responses) at 0.5%.
However, all survey participants agree on one point: 5.00% is the maximum level they believe the policy rate will reach during the current monetary policy tightening cycle. They all expect the policy rate to start declining again in June 2024, with the most optimistic forecasts seeing it drop to 4.75% in April 2024.
Regarding inflation measured by the Consumer Price Index in Canada, it is expected to decrease to 3.5% by the end of 2023, and the 2.0% target will be reached within five years, according to the median of responses in the Bank of Canada's survey. The most optimistic respondents (25th percentile) expect inflation to drop to 3.0% by the end of the year and reach the 2.0% target at the end of 2024. More pessimistic respondents (75th percentile) believe that the inflation rate will remain the same by the end of the year and will be at 2.3% in 5 years. The inflation rate decreased to 3.1% in October, according to the Bank of Canada. It stood at 3.8% in September.
No case for risk
In his weekly economic publication released on November 10, titled U.S.: What the labour market is telling investors, McMahon noted significant volatility in both fixed-income securities and equities, against a backdrop of geopolitical tensions. "We have a neutral position in equities with a slight underweighting of the American market."
McMahon currently sees no macroeconomic argument justifying increased exposure to riskier assets. "We are witnessing an economic slowdown, a slight contraction in sales and corporate profits for S&P 500 companies," he points out.
In the November edition of Monthly Macro & Strategy, iA Global Asset Management outlines its asset allocation positioning. The manager is overweighting the money market and fixed-income asset classes, while slightly underweighting equities and remaining neutral on alternative investments.
iA Global Asset Management maintains a neutral stance on the equity asset allocation in all regions except for U.S. equities, which it slightly underweights. In the fixed-income category, iA strongly overweight government bonds and slightly overweight investment-grade bonds (rated from AAA to BBB-), but steers clear of high-yield bonds (rated below BBB-). iA Global Asset Management also overweights oil and the U.S. dollar index.
U.S. unemployment rate in focus
"Will the U.S. economy go into a recession or slide into a prolonged stagnation?" Sébastien McMahon believes this is the most important question to consider regarding market prospects in 2024. He considers the labor market to be a good indicator for the U.S. economy.
Currently, the unemployment rate is rising in the United States, according to McMahon. He shared a chart from a macroeconomic analysis focused on the Sahm rule (named after economist Claudia Sahm), an indicator of recession based on monthly unemployment data published by the U.S. Bureau of Labor Statistics. The indicator tracks the evolution of the unemployment rate. When the three-month moving average of the national unemployment rate increases by 0.5% or more from its low in the last 12 months, the indicator marks the start of a recession.
"We're not there yet. We're at 0.3% since the low, but we see that the unemployment rate is rising again. Generally, the tide rises for a while, not just a few months," analyzes McMahon.
Waiting for pessimism
iA's Chief Strategist and Senior Economist also points out that the S&P 500 stock index hits a bottom at the end of a recession or shortly thereafter, according to data going back to 1947 that he shared. "The S&P 500 indicates that we are still 12% below the peak we reached in January 2022. We've been in a correction for a while now."
The macroeconomic analysis framework suggests that the U.S. may be heading toward a recession. "The troughs in market declines tend to be at the end of recessions, not before. Stock markets anticipate recessions: when they begin, markets have generally already anticipated them and start to rise again," explains Sébastien McMahon.
As a manager, he believes it's necessary to wait for enough pessimism to build up in the markets for an attractive entry point and for valuations to become enticing. He notes that markets are monitoring when the Federal Reserve will begin cutting its policy rate, likely in the second half of 2024, according to data collected by iA Global Asset Management.
Shaken retirement funds
Retirement funds are affected by economic uncertainty. "The third quarter posed significant challenges for Canadian DB pension plans within the RBC Investor Services All Plan Universe, amidst intricate market dynamics," RBC Investor Services reported, based on its universe of pension plans that it has been tracking for over 40 years.
Pension plans in this universe saw a decline in returns of 4.0% in the third quarter of 2023, "bringing down the year-to-date return to 1.9% for the period ending September 30, 2023."
According to RBC, market volatility is occurring in an economic context dominated by inflationary pressures. It attributes this in part to rising energy costs and geopolitical tensions. RBC points to the conflict between Russia and Ukraine and the intensification of trade disputes.
A similar perspective comes from BNY Mellon Global Risk Solutions fund-level tracking service. The median return of the BNY Mellon Canadian Asset Strategy View Universe decreased by -1.99% in the third quarter of 2023. However, as of September 30, 2023, the one-year median return remained positive (8.01%). The 10-year annualized median return also remained positive, at +6.52%.
The results of the BNY Mellon Canadian Asset Strategy View Universe are based on an investment value of $290.2 billion in Canadian investment plans. "After posting strong performance returns in the first half of the year, the Canadian pension plans stumbled in Q3 due to increased recession fears, a predicted extended period of central bank tightening and an uncertain economic and political environment," said David Cohen, Director of Global Risk Solutions, BNY Mellon.
