Lexicon Financial Group Weekly Update — June 5, 2024
“It all comes down to interest rates. As an investor, all you’re doing is putting up a lump-sump payment for a future cash flow.”
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
June 6 marks the 80th anniversary of D-day, the day in 1944 that troops from Canada, the United States and Britain landed at Normandy in Operation Overlord. Originally codenamed Operation Neptune, this battle proved to be the beginning of the liberation of France and Western Europe and laid the foundation for the Allied victory on the Western Front.
This has very little to do with investing or equity markets but it is just something worth remembering. Often, we get so caught up in markets, interest rates and inflation that we forget to pause and reflect on other things that are as important. This week is no different as what has been dominating newsfeeds is something new but arguably less important on a global or historical scale. Finally, the Bank of Canada has cut its benchmark interest rate by 0.25 per cent (often referred to as 25 basis points or 25 “bips”).
We’re going to talk a lot about inflation and interest rates this week, because we could just be seeing the beginning of the end of the higher-for-longer rate environment, which would come as good news to business and consumers.
We don’t want to minimize the importance of the rate cuts – they come as economic growth in Canada resumed after stalling in the second half of 2023. Canada’s first-quarter GDP growth of 1.7 per cent was slower than forecast but inflation eased to 2.7 per cent in April. The Bank’s preferred measures of core inflation also slowed and three-month measures suggest continued downward momentum. Indicators of the breadth of price increases across components of the CPI have moved down further and are near their historical average. (1)
Source: Factset
So, just as raising rates contributed to inflation in the first place, now that it is not as big a problem, cutting it should nudge the economy forward, towards increased economic development.
According to Capital Economics, this should be the first of many cuts. Capital Economics is, for now, forecasting three more 0.25 per cent cuts in the second half of this year. Absent a big upside surprise to inflation (CPI) in Canada before the late-July policy meeting, the BoC may cut again in July. This is good news for Canadian consumers and businesses as the cost of borrowing will go down. What is more, Capital Economics asserts that there will be further cuts in 2025, which is also good for investors and markets. (2)
Across the pond, a cut of 0.25 per cent in interest rates in Europe is expected to happen soon and, maybe, this week. This cut will be the first in more than five years, drawing a line under the worst of the eurozone’s inflation crisis and easing the pressure on the region’s weak economy. This means that European Central Bank (ECB) policymakers will be leaving their counterparts at the United States (U.S.) Federal Reserve (Fed), which is struggling with a seemingly more persistent inflation problem, behind. Lowering interest rates in Europe before the United States does would create a gap between the policies of two of the world’s largest and most influential central banks. A move by the ECB to ease its policy could weaken the euro, while higher interest rates for longer in the United States could continue to tighten financial conditions there and in other countries because of the global role of the dollar. While the ECB may not always act based on what the Fed does, policymakers acknowledge that they cannot ignore the influence the Fed has on financial conditions and exchange rates all over the world.
Inflation in the eurozone is expected to return to the ECB’s two per cent target next year, as the shock of high energy prices after Russia’s invasion of Ukraine fades. Inflation was 2.6 per cent in May, which was slightly higher than the previous month, but it has slowed significantly from its peak, above 10 per cent, in late 2022. Growth in the eurozone economy was a mere 0.3 per cent in the first quarter of the year, after five quarters of stagnation, so the need to spur growth by a cut in interest rates is important. (3)
Stranger things have happened, but the United States is not expected to adjust interest rates at its upcoming meeting on June 11-12. One or two cuts are viewed as the most likely scenario but currently the chance of an interest rate cut on June 12 is just 0.1 per cent according to the CME’s FedWatch Tool, which measures the likely path for short-term rates based on fixed income markets. At the last update of the FOMC’s Summary of Economic Projections on March 20, two or three interest rate cuts were forecast as the most likely outcomes for 2024. The FOMC’s view, however, has possibly turned a little more hawkish, given relatively strong jobs data and slowing progress on the fight to reduce inflation. Again, for some context, strong jobs data means there are a lot of people working, and those paychecks get spent on goods and services, which has an inflationary effect.
If you have been reading our weekly updates, you know that we have been talking about interest rates almost ad nauseam. Ad nauseam is a Latin phrase that literally means “to nausea” and we expect the nausea to continue as long as interest rates impact economies and the markets.
Looking Back
For the month of May, the Toronto Stock Exchange’s S&P/TSX composite index (TSX) was up 2.55 per cent. The TSX industrials group added 1.55 per cent and consumer staples ended 0.89 per cent higher. Energy was up 1.21 per cent even as the price of oil settled 1.2 per cent lower at $76.99 a barrel ahead of an OPEC+ meeting. Money markets had priced in an 80 per cent chance that the BoC would begin an easing campaign at the policy announcement this week and they were rewarded with a 0.25 per cent cut in interest rates this week. The materials group, which includes metal miners and fertilizer companies, ended 0.58 per cent lower as gold and copper prices fell last week. Worth noting is that, last week, investment industry participants in Canada transitioned to a shorter securities settlement standard of trade day plus one day from two before. (4)
As you can see below, the TSX is lagging the performance of major U.S. markets like the S&P 500 and Nasdaq Composite this year. The reason for this has more to do with sector concentration. The TSX is filled with banks and resource-related stocks while the United States is packed with technology and health care stocks. Sectors, as we have pointed out before, fall in and out of favour. (5)
Currently, the technology sector is the flavour du jour.
Weekly North American Market Statistics
| Index | Week's Change | Year to Date |
| S&P 500 | -0.5% | 10.6% |
| Nasdaq Composite | -1.1% | 11.5% |
| Dow Jones Industrial Average | -1.0% | 2.6% |
| S&P/TSX Composite Index | -0.2% | 6.3% |
Source: Associated Press and Morningstar Direct 05/31/2024
Last Friday also brought further evidence that growth might be picking up in the second quarter. The U.S. Department of Commerce reported that orders for durable goods excluding the volatile aircraft and defence orders—typically considered an indicator of business capital investment—rose a more-than-expected 0.3 per cent in April, after remaining roughly flat over the first three months of this year.
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
Video and Article: Bank of Canada rate cut is ‘going to matter in people’s pocketbooks.’ Here’s why
Real estate investments in China are hemorrhaging value as buyers remain wary
Major markets in the U.S. closed lower over the holiday-shortened week but rounded out a month of gains. Surprisingly, small-caps performed better than large-caps, and value stocks held up better than growth shares. The technology-heavy Nasdaq Composite was especially weak, due in part to a sharp decline in cloud software provider Salesforce, which fell sharply after releasing first-quarter revenues that missed consensus estimates. Markets were closed this Monday in observance of the Memorial Day holiday.
The Commerce Department’s personal consumption expenditure (PCE) price index report (widely considered the Federal Reserve’s preferred inflation gauge) was released last Friday, It revealed that PCE rose 0.2 per cent in April, down slightly from the previous two months.
In local currency terms, the pan-European STOXX Europe 600 Index ended 0.46 per cent lower, as hotter-than-expected eurozone inflation increased uncertainty about policy easing by the ECB beyond June. Major stock indexes ended down last week. France’s CAC 40 Index dropped 1.26 per cent, while Germany’s DAX declined 1.05 per cent. Italy’s FTSE MIB ended the week flat. The UK’s FTSE 100 Index lost 0.51 per cent. Headline inflation in the eurozone rose for the first time in five months, with the year-over-year increase in consumer prices moving up to 2.6 per cent in May from 2.4 per cent in each of the two months prior. This exceeded the consensus estimate of 2.5 per cent. Services inflation spiked to 4.1 per cent from 3.7 per cent in April. Meanwhile, a measure of core inflation that excludes energy, food, alcohol, and tobacco prices rose to 2.9 per cent from 2.7 per cent.
Japan’s stock markets ended last week mixed. The Nikkei 225 Index fell 0.4 per cent and the broader TOPIX Index gained 1.1 per cent. The focus of investors in Japan is still firmly on the prospect and likely timing of further monetary policy normalization by the Bank of Japan (BoJ). The yield on the 10-year Japanese government bond (JGB) rose to 1.07 per cent from 1.00 per cent at the end of the previous week, amid continued uncertainty about when the BoJ could next raise short-term interest rates. Although the BoJ ended its negative interest rate policy in March this year, Japan’s monetary policy remains among the most accommodative in the world.
Chinese equities were little changed after an unexpectedly weak manufacturing reading emphasized economic growth headwinds. The Shanghai Composite Index was flat, while the blue chip CSI 300 gave up 0.6 per cent. In Hong Kong, the benchmark Hang Seng Index lost 2.84 per cent. The official manufacturing purchasing managers’ index (PMI) fell to a below-consensus 49.5 in May from 50.4 in April – falling below the 50-mark level is indicative of moving from growth to contraction. The PMI’s subindexes for new orders and exports also declined. The non-manufacturing PMI, which measures construction and services activity, slipped to a weaker-than-expected 51.1 from 51.2 in April amid slower construction growth.
Although both PMI readings highlighted pockets of weakness in China’s economy, most economists believe that China will still meet its growth target this year of approximately five per cent. Earlier last week, the International Monetary Fund upgraded its 2024 economic growth forecast for China to five per cent, which is up from its April projection of 4.6 per cent. (6)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
Bank of Canada reduces policy rate by 25 basis points, Media Relations, Bank of Canada, June 5, 2024
Bank of Canada Policy Announcement (Jun. 2024), Stephen Brown, Deputy Chief North America Economist, Capital Economics, June 5, 2024
E.C.B. Is Likely to Leapfrog the Fed on Interest Rate Cuts, Eshe Nelson, The New York Times, June 5, 2024
The close: Month-end repositioning spurs late-day stock rally, The Globe and Mail, May 31, 2024
The real story behind Canada's lagging stock market, Bhawana Chhabra, Financial Post, March 5, 2024
Global Markets Weekly Update, T. Rowe Price, May 31, 2024
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Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
Federal Open Market Committee (FOMC): What It Is and Does