This graph shows that real gross domestic product, or GDP, and consumer spending are estimated to soften through early 2024 before rebounding later in the year.
This graph shows that real gross domestic product, or GDP, and consumer spending are estimated to soften through early 2024 before rebounding later in the year.
The Canadian and U.S. economies remained resilient for the first half of 2023, driven in large part by healthy consumption growth. Households continued to spend despite rapidly rising interest rates and tightening lending conditions.
The rising rates however, caught up with Canadians in the second half of 2023, as Q3 growth turned negative. Many Canadians have variable rate and shortterm mortgages, and as rates rose, so did mortgage payments, which impacted Canadians' ability to spend.
In the U.S., economic growth held up through 2023, but we expect growth to soften in the first half of 2024 to below trend growth levels of 1.5%. We believe somewhat weaker consumption, lower government spending, and a cooling labour market will translate to slower growth.
Canadian and U.S. consumers alike face some challenges heading into 2024, including declining savings rates, rising credit card debt, and still-elevated interest rates. In addition, we believe some loosening in the labour market may put downward pressure on wage gains and consumer confidence overall.
While both economies may avoid a textbook recession, a rolling recession may emerge. Parts of the economy, such as manufacturing and perhaps housing, could bottom and then stabilize, while other parts, such as services and consumption, could peak and move lower.
After a year and a half of the Bank of Canada (BoC) and the U.S. Federal Reserve (Fed) increasing interest rates, we believe economic growth may finally feel the lag impacts in 2024. On the positive side, a slowdown in growth could also support lower inflation, reducing the need for further central bank tightening.
As we look to the second half of 2024, we expect growth in both economies to gradually accelerate once again. We believe that the combination of ongoing inflation moderation, possible rate cuts from the central banks, and better corporate margins and earnings growth will lead to improving economic growth later in 2024. As markets are forward-looking, we may begin to see a move higher even before economic growth stabilizes and improves.
For more than two years, the number of job openings has outpaced the number of unemployed. Throughout 2023, however, the gap between the two has begun to narrow.
For more than two years, the number of job openings has outpaced the number of unemployed. Throughout 2023, however, the gap between the two has begun to narrow.
In 2023, a strong labour market gave consumers the confidence to spend in the face of high inflation and rising borrowing costs. But the tight conditions also meant the BoC and the Fed might need to keep policy restrictive to ensure higher labour costs don’t feed into higher inflation.
We anticipate the demand for labour to cool in 2024 as business spending and hiring moderate in response to slower economic growth. This easing could drive wage growth and inflation lower, providing the BoC and the Fed the opportunity to begin cutting interest rates.
In Canada, job creation has been slower than labour force growth. This is mainly due to immigration and as a result the unemployment rate has risen from 4.9% to 5.8%. Despite this, unemployment remains low, supporting income gains. However, the pace of job gains is likely to slow as companies reduce hiring to protect profitability.
The declines in job vacancies, the quits rate, and temporary help payrolls are early signs of softening that will likely lead to a better balance between the supply and demand for labour in 2024. To a lesser extent, labour market conditions could remain supportive. The solid starting point of corporate finances indicates that any rise in unemployment might be moderate.
This graph shows the paths of shelter inflation and sticky price inflation, which excludes food, energy and shelter. While shelter inflation rose higher post-pandemic, both have begun to fall.
This graph shows the paths of shelter inflation and sticky price inflation, which excludes food, energy and shelter. While shelter inflation rose higher post-pandemic, both have begun to fall.
Significant progress has been made on the consumer price front, with core inflation (excluding food and energy) falling materially from the peak in 2022. We think this downward momentum can continue through 2024, with inflation reaching 2.5%.
The silver lining of a deceleration in economic growth is that softer demand will exert further downward pressure on inflation. This, in turn, should enable both the BoC and the Fed to eventually cut interest rates to a more neutral level, acting as a shock absorber that can help avoid a more severe recession.
Further, if labour supply continues to increase alongside rising labour productivity, a trend that has been particularly solid in the U.S., an environment where economic growth holds up while wage pressures and inflation continue to fall could develop.
Consumer goods prices started to decline in late 2023, including a much-needed decrease in vehicle prices. The one notable hold out has been stubbornly high home and rent prices. However, we believe relief is on the way: Recent data is signaling to us that housing prices may allow overall inflation to fall faster in 2024.
This graph shows the BoC and Fed policy rates along with expectations for rate cuts in 2024. The BoC and Fed will likely push back against easing but may end up cutting rates more than the two times they projected this past September.
This graph shows the BoC and Fed policy rates along with expectations for rate cuts in 2024. The BoC and Fed will likely push back against easing but may end up cutting rates more than the two times they projected this past September.
At the core of our outlook for equity and bond markets is the trajectory of central bank policy, which is set to undergo a notable shift in 2024. We believe that, after the most aggressive tightening campaign in 40 years, the hiking cycle for major central banks is complete.
The BoC and the Fed will likely err on the side of caution, signaling an extended pause and keeping the BoC rate at 5% and the Fed funds rate at 5.25%–5.5% in the first half of the year. But easing inflation pressures, a cooling labour market and a slowdown in growth will likely pave the way for interest rate cuts in the second half of 2024.
Policymakers will likely push back against expectations for aggressive cuts to ensure inflation returns to the 2% target. This push and pull between markets and the central banks could drive market volatility. Yet, if price pressures continue to ease as we expect, the real policy rate (after adjusting for inflation) will become more restrictive.
Weaker economic momentum in Canada could drive the BoC to cut rates slightly more than the Fed, potentially bringing its policy rate around 4%. We believe that in the U.S., the Fed will try to offset the higher real policy rate by cutting rates potentially more than the two times projected at the September 2023 Federal Open Market Committee (FOMC) meeting. We expect a modest easing in policy, with the extent depending on core inflation approaching the Fed’s 2% rate target.
This graph shows that since 1990, the 10-year and 2-year Treasury yields have tended to peak around the last Federal Reserve rate hike in a cycle.
This graph shows that since 1990, the 10-year and 2-year Treasury yields have tended to peak around the last Federal Reserve rate hike in a cycle.
In 2023, Canada's elevated wage growth and the BoC's rate hikes pushed the 10-year Government of Canada (GoC) yield to 4.25%. Subsequently, central bankfriendly data have supported a gradual bond recovery.
In the U.S., an unexpectedly strong economy, the Fed’s higher-for-longer messaging on interest rates, and increased Treasury issuance for the expanding fiscal deficit pushed the 10-year Treasury yield to 5%, its highest point in 16 years.
We think conditions are in place for both central banks to stop hiking rates, removing some major resistance to bond performance. Looking at historical U.S. data, we’ve seen seven major Fed tightening cycles over the past 40 years. In each, short- and long-term yields were lower six months after the last hike, declining about 1% on average.
While it’s hard to pinpoint, we anticipate a similar trend this time, suggesting that last year’s surge in interest rates might have marked the peak for this cycle. The policy-sensitive 2-year GoC yield could fall more sharply, reflecting expectations for rate cuts, while the growth-sensitive 10-year GoC yield could decline more modestly if a recession is averted.
The yield curve represents the difference between short-and long-term yields. We see the 10-year yield falling slightly below 3% in Canada and 4% in the U.S., accompanied by a steepening yield curve. After being inverted for the longest stretch since the early 1980s, the yield curve could turn positive.
This graph shows average and median returns for the S&P 500 since 1930, broken down by the four years of a presidential cycle.
This graph shows average and median returns for the S&P 500 since 1930, broken down by the four years of a presidential cycle.
After double-digit declines in 2022, both the TSX and S&P 500 experienced solid rebounds in 2023, albeit driven by a narrow set of sectors and large-cap tech stocks. We believe the stock market has room to continue to build on 2023’s gains and move higher, with the potential for the U.S. market continuing to outperform the Canadian market.
These gains may come from corporate earnings growth, which we believe will accelerate to 5%–10% for the S&P 500 next year, and some valuation expansion, especially as interest rates continue to moderate. Stocks outside of the mega-cap technology space may offer better prospects for valuation expansion.
We expect stock markets to end higher in 2024, but with their fair share of volatility. Markets may not be able to ignore a potential economic slowdown in the first few months of 2024, which we expect to be more severe in Canada than the U.S. However, without a deep and prolonged downturn, we believe markets can look past a slowdown to a period of growth ahead.
2024 is a U.S. presidential-election year, which could spark some headline volatility and near-term uncertainty, but historically, election years have been positive for the markets. Once the election is over, and the uncertainty over which political party holds the balance of power in the U.S. is removed, the markets will have a clearer picture with regards to any new legislation or regulations that may be imposed.
With the U.S. Congress still divided, we expect gridlock to remain in place in 2024, regardless of the election outcome. This typically means no new legislation or regulations are passed, which markets tend to like as it makes the operating environment more favourable for companies.
Overall, we see a trifecta of fundamental factors that may favour Canadian and U.S. stock market performance in 2024:
- Ongoing moderation in inflation;
- The potential for the BoC and the Fed interest rate cuts;
- A growth re-acceleration in the second half of the year. A growth re-acceleration in the back half of the year
This graph shows the forward price-to-earnings ratio for the Magnificent 7 stocks of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla is nearly double that of the S&P 500 when all stocks are given equal weight.
This graph shows the forward price-to-earnings ratio for the Magnificent 7 stocks of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla is nearly double that of the S&P 500 when all stocks are given equal weight.
A key theme in the stock market for 2023 was narrow leadership, with mega-cap technology driving much of the gains. In 2024 we would expect some laggards to play catch-up.
We see this playing out in two phases of the economic cycle. Early in 2024, we expect both the Canadian and U.S. economies to remain in the “late cycle and economic slowdown” phase. During this time, we expect investors to gravitate toward parts of the market that have been working well, such as large-cap technology, and perhaps tilt a bit more defensively in sectors such as health care and staples.
Once the late cycle or downturn is confirmed, markets may look quickly toward an early cycle economic recovery. This phase of economic growth is when we see the typical recovery playbook emerge: Leadership tends to be in areas such as small-cap stocks and cyclical parts of the market that are leveraged to economic growth, including industrials and consumer discretionary. International and emerging-market stocks may also lead, especially if global growth is rebounding.
With generative AI (artificial intelligence) in the early innings of multiyear growth, we still view the large-cap technology space favourable but see diversification beyond technology more critical to portfolio returns in 2024.
The 'Magnificent Seven' stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) have enjoyed full valuations, perhaps somewhat justified given their consistent earnings growth overall.
However, stocks outside large-cap technology may have a better chance for valuation expansion in the year ahead. As the economic cycle turns in 2024, so could stock market leadership.
This graph shows that since 1984, bond performance six months after the last Federal Reserve interest rate hike has outperformed performance six months before the last Fed hike.
This graph shows that since 1984, bond performance six months after the last Federal Reserve interest rate hike has outperformed performance six months before the last Fed hike.
After a rough start in 2023 and after underperforming cash over the previous two calendar years, investmentgrade bonds ended the year on a strong note. Despite the attractive yields in Guaranteed Investment Certificates (GICs) and short-term bonds, which carry little or no price risk, we see compelling opportunities in intermediate and long-term bonds, which have higher sensitivity to interest rate changes.
The end of the BoC and Fed tightening has historically meant above-average bonds returns. An upcoming inflection point in the interest rate cycle, combined with historically attractive valuations, could mean cash will give up its lead in 2024. If the central banks pivot to lower rates later in 2024, we see an opportunity for investors to slightly extend the duration of their bonds.
If GICs represent an oversized part of a fixed-income portfolio, we recommend reducing the cash allocation or reinvesting the maturing principal into longer-maturity bonds. These bonds can help investors lock in the historically high yields for a longer period. They also may appreciate as the BoC and the Fed make further progress toward their 2% inflation target.
On the credit side, spreads have remained contained supported by strong corporate fundamentals but could widen if growth cools.
This graph shows the S&P Global Composite Purchasing Managers’ Index, or PMI, for the eurozone, China, Japan, the United Kingdom and Canada. The eurozone, U.K. and Canada have fallen into contraction. China’s and Japan’s PMIs have declined but remain in expansion.
This graph shows the S&P Global Composite Purchasing Managers’ Index, or PMI, for the eurozone, China, Japan, the United Kingdom and Canada. The eurozone, U.K. and Canada have fallen into contraction. China’s and Japan’s PMIs have declined but remain in expansion.
We believe European economic growth could stall in 2024, with the potential for a brief, mild recession. In Europe, higher interest rates have weighed on economic activity, particularly within the manufacturing sector. Despite the impact of central bank rate hikes and slowing growth, inflation remains above central bank targets.
In the United Kingdom, CPI inflation excluding food and energy rose by over 6% year over year in October 2023. Additionally, measures of U.K. wage growth have failed to moderate, rising nearly 8% year over year in late 2023. If this situation remains, it could lead to stubbornly high inflation and force central banks to keep rates higher for longer.
The outlook for China and Japan looks brighter. In China, deflationary and property sector concerns have led policymakers to enact stimulus measures to help bolster economic and financial market activity. While risks remain, we believe the enacted stimulus could offer support to the Chinese economy in 2024.
In Japan, inflation is higher by historical standards but has been contained, with headline CPI peaking at 4.4% in January 2023. Some inflation is likely welcome for Japan, after it struggled to fight off deflationary pressures for much of the past three decades. While higher inflation could weigh on consumer confidence and spending, still accommodative policy, steady wage growth, and a tight labour market could help offset these headwinds in 2024.
While economic trends could diverge, the potential for a modestly lower Canadian dollar could boost international returns in Canadian dollar terms. The Canadian Dollar (CAD) relative to the U.S. Dollar (USD) has spent much of the past seven years between U.S.$0.70 - $0.80 and most of 2023 in the middle of that range. Two factors that tend to drive the CAD/USD exchange rate are interest rates and oil prices, which could lead to the Canadian dollar hovering in the low end of that long-term range in 2024.
Differences in interest rates favour the U.S. which we expect will continue into 2024. Economic growth in Canada could stagnate in 2024, which along with downward trends in domestic inflation, should support the BoC pivoting to interest rate cuts. While the Fed is likely on a similar path to cut rates in 2024, resilient economic activity in the U.S. could prevent the Fed from cutting policy-rates as aggressively in 2024 as the BoC, leading to higher U.S. rates and a softer Canadian dollar. Oil prices could have a neutral influence on the CAD as upward pressures from geopolitical uncertainties are offset by moderating global growth.
This graph shows stock market performance, as represented by the S&P 500, in election years since 1952.
This graph shows stock market performance, as represented by the S&P 500, in election years since 1952.
This graph shows delinquency rates for commercial real estate loans going back to 1993.
This graph shows delinquency rates for commercial real estate loans going back to 1993.
We've seen some weakness emerge in the Canadian residential real estate market recently, an unsurprising trend given rising mortgage costs. We think some softness could persist in overall housing activity, but we don't expect this to result in a crash in prices. However, we think the more acute impact will be felt in domestic economic growth, as elevated consumer debt levels, higher mortgage payments and slower wage growth will impact overall household spending (which comprises nearly 60% of Canada's GDP) in 2024.
A view that gained popularity amid 2023’s U.S. banking turmoil was that a coming crash in U.S. commercial real estate would trigger a larger financial and market crisis. We don’t believe this will be the case, but we do think a slowdown in economic activity will bring some credit stress. We expect overall loan delinquencies and losses to rise in 2024, with the shifting post-pandemic real estate landscape possibly exerting the most pressure on commercial property prices and loan performance.
We do not, however believe loan defaults will cause wider economic damage. U.S. commercial real estate investment and prices haven’t experienced the same mania as U.S. residential housing did in the late 2000s. Instead, we think some evidence of deteriorating credit conditions could resurface worries about loan losses for the banking sector and resulting capital constraints. This could spark an episode of volatility in the broader markets, although we doubt it will be a repeat of the U.S. regional bank failure turmoil experienced in March 2023.
2024 is a U.S. election year but history shows that the partisan outcomes of U.S. presidential elections don’t play a material or lasting role in dictating market performance, however there is often volatility leading up to an election. The lesson history teaches every four years: Markets will be guided by the path of the broader economy, earnings, and interest rates, rather than the outcome on election day. Equity markets will likely react to U.S. political headlines, but any election-driven weakness will probably be temporary.
Having said that, we doubt the election will clear the gridlock in Washington, which offers a potential silver lining for markets by reducing the likelihood of new, sweeping regulation. At the same time, the longer-term geopolitical backdrop remains unknown, as the president will likely further shape the tone with China and global alliances. Given the ongoing conflict overseas, we believe geopolitical tensions will be the source of temporary but noticeable weakness in 2024.
