Financial Letter - First quarter 2024

The global equity markets began 2024 on a positive note. All the major indexes posted gains, extending the strong performances they recorded last November and December. Once again, the developed markets rose on the hype surrounding artificial intelligence (AI), the strength of the U.S. economy and the prospect of monetary easing this year by the world’s major central banks. Emerging markets rebounded from a challenging January, buoyed by the February rally in Chinese equities, but also by the AI craze.

Investors generally continued to expect several rate cuts from the major central banks, thanks to falling inflation data. At its latest meeting, the U.S. Federal Reserve (Fed) was still considering three rate cuts of 25 basis points each, for a total reduction of 0.75% in 2024, according to forecasts by the members of the Federal Open Market Committee (FOMC), which sets the Fed’s monetary policy. As for the Swiss National Bank, it decided to lower its key interest rate, becoming the first of the major Western central banks to adjust its monetary policy since the tightening cycle began in 2021.

  Sources: FTSE International Limited, S&P Dow Jones Indices LLC and MSCI Inc.

  Sources: Bank of Canada, Fundata, U.S. Energy Information Administration.

Source: Trust National Bank.

Canadian fixed income

Toward the end of 2023, bond yields fell rapidly as the market priced in aggressive rate cuts starting in March of this year. As falling yields drove up bond prices, the Canadian fixed income market recorded a remarkable end to the year.  

Even so, the progress made on inflation hasn’t been convincing enough to justify the rapid, aggressive rate cuts expected by investors. In the United States, inflation is cooling, but the economy remains robust, and its strength is standing in the way of bringing inflation back down to the target. The latest figures show that, in February, year-over-year inflation rebounded slightly to 3.2%, whereas the Fed’s target is 2%. As a result, investors have curbed their enthusiasm since the start of the year. As of March 31, 2024, they now expect rate cuts to begin in June. 

In Canada, investors have also revised their expectations downward. Even though inflation declined for the second consecutive month in February, the Canadian economy was surprisingly resilient at the start of the year. Economic data showed 0.6% growth in January, the highest rate in a year. Statistics Canada noted that the increase was partly due to the end of public sector strikes in Quebec in November and December.

This further readjustment of expectations caused the yield curve to rise slightly in Canada in the first quarter. As a result, the Canadian bond market ended the period with a return of -1.2%, as measured by the FTSE Canada Universe Bond Index.

The key factors for the Canadian bond market are still the rate of inflation and the frequency and magnitude of rate cuts. In Canada, the latest figures show year-over-year inflation at 2.8%, a rate within the Bank of Canada’s target range of 1% to 3%. Even so, the share of inflation from services¹ remains high. It is more difficult to get this component of inflation back below the target because of its correlation with wages. 

The Bank of Canada has yet to provide clear guidance on the timing and magnitude of rate cuts, and it remains to be seen whether its actions will correspond to the market’s expectations. One thing is sure: fixed income offers increasing protection in the event of a recession and a stock market downturn.

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The Canadian stock market closed the first quarter of the year at another all-time high, posting a return of 6.6%, as measured by the S&P/TSX Composite Index. The return was due mainly to the energy sector; after lagging in 2023, it rebounded throughout the quarter on higher oil prices due to OPEC+ supply cuts. The surprising growth of the Canadian economy also buoyed the stock market. 

The first quarter of the year saw the S&P 500 Index make a total of 22 all-time highs for a return of 13.5% in Canadian dollars. This exceptional performance was again driven by hopes that the Fed would be able to achieve a soft landing for the U.S. economy, if it was not already doing so.

Even though we cannot illustrate the likelihood of a soft landing south of the border, we can illustrate the general perception of recession risk in the U.S. economy. The chart below shows the median probability of recession in the United States, namely the likelihood that the country will enter a recession in the next 12 months according to a consensus of economic experts, analysts and financial institutions. As at March 31, the index indicated a 35% chance that the U.S. economy would enter a recession, down from almost 65% a year earlier. This decline in the risk of recession reflects the market’s optimism about the economy.

But it isn’t just investors who are positive. The University of Michigan’s Consumer Confidence Index has also improved. It measures how optimistic U.S. consumers feel about the state of the economy. After hitting an all-time low in 2022 during the aggressive tightening cycle, the latest data have reached an almost three-year high. 

A number of factors are contributing to this renewed optimism: a robust employment rate in the United States, falling inflation that gives the Fed breathing room to focus on growth, and the ongoing enthusiasm over artificial intelligence. 

International equities and emerging markets were no exception and also recorded positive results. 

As with the North American markets, European equities were boosted by expectations that the European Central Bank would start cutting interest rates in June. In March, investor confidence in Germany’s economic outlook reached its highest level in more than two years. The hype surrounding AI and GLP-1 weight-loss drugs also propelled some European companies upward, contributing to the positive trend. The MSCI Europe Index ended the quarter with a return of 8.2% in Canadian dollars.

In contrast to the Western central banks, the Bank of Japan raised its interest rates for the first time in 17 years, ending its negative interest rate policy. This reversal is due to above-target inflation and strong wage growth. This inflation is seen as a positive sign in Japan, indicating a recovery in growth after years of deflation or moderate inflation. This trend contributed to the positive performance by the MSCI All Country Asia Pacific Index, which returned 7.9% in Canadian dollars, with the Japanese market alone accounting for more than half of the gains. 

In emerging markets, Taiwan’s strong performance due to its high exposure to the information technology sector helped drive up the MSCI Emerging Markets Index, which returned 5.1% in Canadian dollars.

The year got off to a strong start amid increasingly optimistic expectations. Even so, a year ago, the consensus was quite clear: an economic slowdown, or even a global recession, seemed inevitable. Human nature often causes us to focus on recent events, but a reversal isn’t impossible. There’s no denying that there are many risks we should be on the lookout for.

In the United States, although the probability of a recession has decreased, it is not zero. The lagged effects of rate hikes and the persistence of some signs of recession, such as the inverted yield curve, are still important considerations. The fall election adds an extra layer of uncertainty, with potential implications for economic policies in a politically divided country. 

Massive government debt is also putting pressure on the global economy, fuelling fears of an economic slowdown and financial volatility, while geopolitical conflicts persist. The coming inflation data and the possibility of a later-than-expected interest rate cut will also be key factors in the months ahead. 

The multiple issues and uncertainties discussed above partly explain why the price of gold reached a new high at the end of March. Gold is regarded as a hedge against inflation and a safe haven.
  
In a context where expectations seem to fluctuate rapidly and sometimes in contradictory ways, maintaining a long-term vision can be challenging. Yet it is precisely at such times that such an approach is of paramount importance.

The managers of the FÉRIQUE Funds take a long-term view by focusing on companies that don’t rely on a particular economic context, such as rate cuts or election outcomes. They incorporate various scenarios into their company valuations and build diversified portfolios that can do well during a variety of market cycles.

Ultimately, as economic and geopolitical challenges continue to arise, a well-thought-out, long-term approach is vital so that investors can navigate market turbulence successfully and maintain long-term financial stability.