Financial Letter - Second quarter 2024

The global equity markets generally continued their upward trend in the second quarter of 2024, despite mixed market performances. Investors had to deal with a complex macroeconomic backdrop, marked by heightened geopolitical risks and important elections in Europe and elsewhere in the world. Even so, the artificial intelligence (AI) frenzy continued to propel the world’s big tech companies to all-time highs, while interest rate cuts by the Bank of Canada and the European Central Bank raised hopes of monetary easing in the United States. 

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

  Sources: Bank of Canada, Bloomberg Finance L.P.

Source: Trust National Bank.

Canadian fixed income

Mortgage holders eagerly awaited the latest interest rate decision by the Bank of Canada, which cut its key rate in June by 25 basis points to 4.75%. 

Even though some central banks in Latin America and the Swiss National Bank in Europe had already cut their key rates earlier this year, Canada was the first G7 country to ease its monetary policy. The European Central Bank followed suit and also lowered its key interest rate in June. The BoC’s decision was based mainly on a decline in inflation below 3% since the start of the year as well as the country’s weaker growth indicators. 

Months of anticipation and speculation by investors in the Canadian bond market about the timing and magnitude of rate cuts led to volatility. Thus, the move at the beginning of June marked a turning point that was welcomed by the market. Even so, April’s negative performance and May’s inflation report limited the gains, with the FTSE Canada Universe Bond Index returning 0.9% for the second quarter.

Outlook

From the bond market perspective, Canada’s first interest rate cut is encouraging. That being said, the Bank of Canada remained conservative in its outlook. BoC officials said that there were still inflationary risks and that progress toward the 2% target would be uneven. In fact, inflation accelerated slightly again in May to 2.9% according to Statistics Canada’s Consumer Price Index. 

Moreover, Canadian interest rates are also influenced by U.S. rates, because the two economies are closely interconnected. The decisions by the U.S. Federal Reserve (Fed) will, therefore, continue to affect the expectations of the bond and stock markets. 

At the end of the first half, the markets were pricing in at least one more rate cut by year-end in Canada and two in the United States.

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Canadian equities struggled in the second quarter, turning in a rollercoaster performance. The S&P/TSX Composite Index ended the period with a return of -0.5%. The market had to constantly adjust to economic and inflationary data that alternated between encouraging and disappointing, despite the BoC’s initial interest rate cut. 

After a negative April, Canadian equities recovered in May on strong performances by the energy and materials sectors. Even so, the inflation data released in June caused the Canadian stock market to decline once again because of its exposure to the same sectors (materials and energy), which are cyclical and, therefore, more sensitive to economic variables. Moreover, the economic slowdown and deteriorating credit quality prompted Canadian banks to increase their loan-loss provisions in the event that borrowers cannot service their debt.

The U.S. market reached new highs in the second quarter despite a mixed performance in April. The S&P 500 Index returned 5.4% in Canadian currency for the period.

Its performance was due almost entirely to the information technology sector, with half of the sectors (six out of 11) recording losses during the quarter. This situation was due to the dominance of a handful of tech mega caps driven upward by the ongoing enthusiasm for AI. Nvidia, known for its high-performance graphics cards and advances in artificial intelligence, even briefly became the most valuable company in the world. 

Moreover, amid signs of a slowdown in the U.S. economy and labour market, investors remained optimistic that the U.S. Federal Reserve would cut interest rates by year-end. Data released at the very end of the quarter indicated that inflation was cooling in the United States and reinforced this sentiment.

Most of the quarter went by without any major problems for the European market, which benefited from encouraging inflation data that even gave rise to expectations of interest rate cuts. But the situation took an unexpected turn after the European Parliament election: French President Emmanuel Macron dissolved the National Assembly and called a snap election. 

France’s stock and bond markets endured a brutal sell-off owing to the election’s highly uncertain outcome and potential economic impact. The CAC 40 Index, the benchmark for the Paris Bourse, fell sharply, wiping out most of the gains since the start of the year. Credit spreads between 10-year French and German government bonds reached a record in response to the turmoil in the markets. Spreads help investors assess risk. The wider the spread, the higher the perceived risk. If the spread between France and Germany increases, it means investors consider lending to France riskier than lending to Germany.

Even so, the MSCI Europe Index managed to end the quarter with a return of 2.0% in Canadian dollars.

Asian and emerging market equities performed relatively better. The MSCI All Country Asia Pacific Index and the MSCI Emerging Markets Index ended the quarter with returns of 3.8% and 6.3%, respectively, in Canadian currency. These markets were lifted by signs of economic recovery in China until mid-May and rising technology stocks in Taiwan, which also benefited from the trend toward AI. India also contributed positively to the return thanks to its solid growth prospects.

The second half of 2024 is shaping up to be a period of transition and volatility, as investors face multiple challenges and uncertainties, particularly in the United States.

For several months, investors have been expecting central banks to cut interest rates. Now that the easing cycle has begun, all eyes are on the Fed and its next move. Will the decrease in inflation be deemed sufficient for it to start cutting rates? The soft-landing thesis is still widely favoured, but will the slowdown in the U.S. economy and labour market be moderate enough to avoid a recession? Precipitous rate cuts could revive inflation; but, if a cut comes too late, the economy could struggle under the weight of interest rates and fall into recession. 

In addition, the risk of concentration in the U.S. market is especially pronounced. The AI frenzy has caused the information technology sector’s weighting in the S&P 500 Index to spiral upward. It’s now approaching its all-time high of 35% reached during the dot-com bubble in the early 2000s. A significant correction in technology stocks could have a substantial negative effect on the market as a whole. 

Finally, the U.S. election could also have a major impact on the markets, whether as a result of domestic politics, the trade war with China or global geopolitical conflicts.

Investing in the stock markets can be complex. Diversification is one of the best ways to reduce risks and increase a portfolio’s resilience. Moreover, in times of uncertainty and volatility, active management can allow for more dynamic risk management. Portfolio managers can adjust their holdings quickly in response to political and economic events while staying true to their long-term strategy. During election periods, when markets can react strongly to voting results and political announcements, such responsiveness is crucial.

It’s also vital to take a long-term view. Investment is comparable to a marathon, not a sprint. You have to avoid reacting to short-term market fluctuations and stick to your plan. 

An advisor and mutual fund representative can help you paint your financial portrait and define a plan that’s based on your long-term vision but evolves according to your life events, allowing you to achieve specific goals on your path to financial independence.