Financial Publications

Hello everyone, welcome to Economic Impact. Today is October 17^th 2024, and as usual I am with our Chief Economist, Stéfane Marion, who exceptionally is in Calgary right now and we are at a distance. Hello, Stéfane, how are you today?

Good morning, Denis. So we're doing this remotely this morning.

Yeah, remotely exactly. Stéfane, you know, we've been talking about the stock market for a while and we said we should be prudent but despite of that, the stock market keeps going up.

Yeah, the enthusiasm is still there Denis. We're hitting an all-time high and it's in many regions of the world driven by both expectations of more rate cuts by the central banks. So we're talking about the synchronized monetary easing cycle and also expectations that, you know, we could have sizable fiscal stimulus from countries such as China that will help support global growth and obviously earnings going into. But I have to say, Denis, there's a lot of these expectations that are already embedded in current valuations.

And at the same time, you know, valuations are quite high compared to the past.

Yeah.

So if we look at this slide and the little red, you know, sorry– yellow dots shows the beginning of easing cycles in the US And you can see that it's exceptional for the US stock market to be valued at 21 or close to 21 times forward earnings at the beginning of an easing cycle. So there's only one precedent for such a situation, Denis. So again, we're navigating into unusual waters if you want and on certain waters, I would say when it comes to valuations on the stock market.

Yeah. And we're seeing on that graph that only a two time out of seven we saw the market going down after rates cuts. And you know, it's interesting to see where we are in the cycle compared to the past. But also, the next slide will show us how the market interprets, you know what's going on in term of you know, valuation and volatility. And I would say the first three lines, that's quite busy. But it's quite interesting because it shows, you know, as the market is doing different signals depending on what you look at.

Yeah, so you're right. So that, you know, the blue bar represents the range in which the market has already as traded in the past. The green line, if you want, the green number represents where we are now versus what you see on average in any other episodes. So you can see that valuations, you know, trading at, you know, almost 21 times forward earnings is quite high relative to the norm. The fact that, you know, earnings expectations are at 14% versus normal of 10% means that, you know, we're expecting significant growth in the months ahead. And the stock market has not really corrected historically the Fed starts cutting rates once the stock market starts correcting, which hasn't been the case this time around. So from a stock market, the first 3 bar show that, yeah, there's a lot of good news already expected in the stock market.

And at the same time, the last three bar are giving a different signal. The one what we call the MOVE is the volatility on the bond market, the VIX is the volatility on the stock market and after that the corporate spread and all of those data are, you know, below the line.

So historically the markets a little bit nervous because you know, the Fed starts cutting rates because maybe something's happening to the economy. So this time around the stock market is already concluded that this is a soft landing and other markets are saying it's going to be a perfect soft landing with no volatility. You can't get more perfect than this Denis because volatility for bonds or for the stock market is well below the historical average and corporate spreads are the least stress we've ever seen at the beginning of the easing cycles. So again, there's a very strong conviction in the markets that the soft landing is mission accomplished, and it only gets better from this point on.

Yeah. And but, you know, there's probably cloud above our head because when you look in the United States, you know, the very small business optimism is not there.

Yeah. So small businesses in US, and we said it before, the uncertainty index is important to look at because they account for 50% of job creation. So I do recognize that the latest jobs report in the US was stronger than expected. But, you know, it seems like it broke the trend from the past six months to me. But I don't think, you know, one month makes a trend. So we'll have to see another good employment report before we change our mind on a potential stress on US labor markets that could undermine profit expectations. But I have to say, people always claim that an election year is good for equities. It's been the case so far. I get this, Denis. But at the same time, we've never seen so much uncertainty prior to US election, and that's quite evident in this slide. So my point, Denis, here's, yeah, if we are going to change our view on the US economy, let's wait for another jobs report. But more importantly, let's wait for the result of the US election and to see whether it's contested or not by one of the two candidates. Both candidates could also contest. We'll see that, Denis. So I think, you know, going into the US election, we've never seen so much uncertainty. And at the small business level, that should transpire theoretically with less aggressive hiring. But let's see the next job report to see if I'm right or not on that one.

Yeah. And we won't wait too long because all of this will happen the beginning of November, then we'll know more really at the start of November about that.

When we meet next month in person, then we will be able to assess the whole situation.

Yeah, might be quite different. But if you come back in Canada, you know, the story is a bit different where, you know, the economy is not doing so well.

Yeah. So people are uncertain about this, you know, the health of the US economy. I have strong conviction that from a Canadian perspective, we're not that great. It's pretty weak. If you look at the manufacturing sector, it's stagnation. If you look at the service sector, it's contraction. So I know the latest jobs report in Canada, like in the US, was better than expected. But I think the uptrend on the unemployment rate is still intact. And that suggests that the Canadian economy is underperforming, Denis. So yes, we're looking at yet another quarter of weak growth in Canada. It's not a recession, Denis, don't get me wrong, but it's still below potential growth and it's underwhelming. And underwhelming growth means higher unemployment in the months ahead.

But probably more and bigger rate cuts have to come in Canada.

Yes, Denis, because underwhelming growth means that inflation is coming down quite significantly in Canada. So headline inflation surprised everyone at 1.6% only in September. Notice on this slide Denis, if you exclude the mortgage interest rate component, which you know the cost of financing your mortgage inflation is only at 1%. But Denis, if you exclude shelter on which the Bank of Canada has no control because of surging population growth, we're at 0.4%. Denis, that is extremely low, I cannot justify keeping rates where they are right now in Canada. I have to up the ante on rate cuts in Canada, 25 basis points is just too slow, they have to move to 50 basis points increment. And that's where the whole Canada.

But if you go province by province, some provinces are not that great too. They are in deflation situation right now, in territory of deflation.

Yeah, actually it's a good point. If you exclude, if you look at inflation, excluding shelter, it's at 0.4%, so anemic at the national level. But there are 4 provinces we're actually talking about deflation. So prices actually coming down if you exclude the shelter component. Those four provinces, Denis, it would be Quebec, Manitoba, New Brunswick and Saskatchewan. So you rarely see so many provinces showing deflation. So as I said before, the Bank of Canada, despite the rate cuts, monetary policy is overly restrictive. They need to start cutting rates by  basis points increment because now Denis what they've been doing, they've been cutting rates, but inflation is falling faster, which means that you're not you're not moving the needle on real interest rates. So 50 basis points would be my best guess for next week and another 50 basis points after that. We got to come back to % very quickly to help the economy for next year.

Well, on that positive note for consumers. Thank you very much for being with us, Stéfane. And hopefully next time we'll be close together in the same room. And thank you all for being with us. We'll see you next month, beginning of November.

Thank you.