Financial Letter - Third quarter 2024

Volatility was heightened in the third quarter because of uncertainties related to global economic growth, monetary policies and geopolitical tensions. Even so, the global stock markets continued their upward trend. Canadian equities were especially strong, outperforming their U.S. and international counterparts. Emerging markets also surged on the back of massive stimulus measures announced in China at the end of the quarter. 

  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

The Bank of Canada’s monetary policy reached a turning point in the second quarter with an initial interest rate cut in response to the country’s lower inflation and weaker growth indicators.  

The BoC initially took a cautious approach, but its recent progress in taming inflation, which reached the 2% target in August on a year-over-year basis, strengthened the case for more monetary easing. Two further cuts of 25 basis points were announced in the third quarter, bringing the key rate down to 4.25%. 

The U.S. Federal Reserve’s monetary policy also had a major impact on Canadian bond yields, because the two economies are closely interconnected. The Fed’s 50-basis-point rate cut, widely anticipated by the markets, helped reinforce expectations of further cuts in Canada.

This context of falling rates on both sides of the border boosted investors confidence, which supported bond yields. The FTSE Canada Universe Bond Index returned 4.7% on the quarter. 

Outlook

In August, inflation fell to its lowest level since the pandemic, reaching the Bank of Canada’s long-term target of 2%. In Quebec, inflation fell even further, to 1.5%. 

Falling inflation gives the Bank of Canada some leeway to pursue its accommodative monetary policy. Accordingly, the market is pricing in additional rate cuts by year-end and next year as well. As of September 30, it was expecting two or three more cuts this year, for a possible total of 75 basis points. 

The reductions are welcome news not only for mortgage holders but also for businesses, which are seeing their financing costs go down slightly. 

That being said, it’s important to note that uncertainties about the Canadian and global economic outlook, geopolitical tensions and labour market fluctuations in Canada and the United States could limit the magnitude of further rate cuts. Another key factor to monitor is U.S. rates. If the Fed takes a cautious approach to rate cuts, it could dampen expectations of further easing in Canada. 

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After a difficult second quarter marked by an uneven performance, Canadian equities rebounded in the third quarter, with the S&P/TSX Composite Index returning 10.5%.

The recovery was due mainly to strong performances by the financials and materials sectors, two pillars of the Canadian stock market. As a result of lower interest rates, Canada’s banks benefited from a reduction in concerns about borrowers’ ability to repay their debts. As for the materials sector, it benefited from higher prices for gold and other metals. 

The U.S. market reached new highs for the third consecutive quarter, with the S&P 500 Index returning 4.5% in Canadian dollars. 

Even so, volatility spiked during the quarter. In early August, the Volatility Index (VIX), widely known as the “fear index,” reached its highest level since 2020. The VIX measures the implied volatility of U.S. stocks, especially those in the S&P 500 Index, over the coming 30 days. It does not measure realized (or historical) volatility but rather the market’s expectations of volatility, making it an indicator of the uncertainty, or the risk level, perceived by investors. When the VIX is high, investors expect concerns or uncertainty to cause significant movements in the market. Conversely, a low VIX suggests investors expect relative stability.

In this case, the spike in volatility was caused mainly by the release of disappointing U.S. economic data, particularly unemployment and manufacturing numbers that revived recession fears.

Eventually, the anxiety dissipated and the market rallied as the direction of U.S. interest rates became clearer. Fed Chairman Jerome Powell adopted a decidedly dovish tone at the central bank’s annual conference in Jackson Hole, hinting that rates could be cut at its mid-September meeting. 

Hints became reality when the Fed lowered its key rate by 50 basis points in September. Investors welcomed the long-awaited decision. The U.S. market ended the quarter on a positive note, buoyed by increased confidence in the Fed’s ability to achieve a soft landing for the U.S. economy.  

International and emerging market equities were also positive, although the dynamics varied from one region to another.

In Europe, signs of an economic slowdown intensified, especially in Germany, where the threat of a recession increased. The Purchasing Managers Index revealed a sharp contraction in the manufacturing sector, prompting the European Central Bank to cut its key rate once again. Even so, the MSCI Europe Index managed to close the quarter with a gain of 5.3% in Canadian dollars, mainly because of a strong performance by the financials sector.

Bucking the trend in the West, the Bank of Japan raised its key interest rate to 0.25% for the first time since 2008. This announcement, combined with a possible further increase and signs of a slowdown in the United States, triggered a wave of panic selling in the Japanese market on August 5, when the Nikkei recorded its largest one-day drop since 1987. 

Despite the turbulence, Asia and emerging markets continued their upward trend on the strength of an unprecedented economic stimulus package announced by China at the end of the quarter. The government and the People’s Bank of China stepped up their efforts with a combination of fiscal and monetary policies designed to support the property market and to boost consumer spending after months of economic decline.  

The MSCI All Country Asia Pacific Index and the MSCI Emerging Markets Index ended the quarter with returns of 7.8% and 7.5%, respectively, in Canadian dollars. 

The second half of 2024 was expected to be a time of transition marked by increased volatility, a prospect confirmed by developments in the third quarter. The trend should continue in the coming months as investors grapple with a complex set of economic and geopolitical factors.

The monetary policies of the major central banks will continue to play a pivotal role. In Europe, the economic situation is more fragile. The slowdown in Germany, one of the main drivers of the European economy, is weighing on the medium-term outlook. Inflation persists in some sectors, while growth is stagnant, making it difficult for the European Central Bank to choose between supporting the economy and controlling prices.

In the United States, the Fed’s expected rate cuts should support the thesis of a soft landing. This optimism is tempered, however, by analysts who think it may already be too late to avoid a recession. Despite the decline in inflation, the key question is whether the rate cuts can boost growth sufficiently without reviving inflationary pressures.

At the same time, the U.S. presidential election in November has added an element of uncertainty. Since Joe Biden’s withdrawal from the presidential race in July, the outcome of the election has only become more unpredictable. This volatile political climate could amplify market movements in the short term, particularly in light of expectations regarding the two candidates’ economic policies. 

Finally, geopolitical conflicts, especially in Eastern Europe and the Middle East, will continue to put significant pressure on markets. The war in Ukraine and rising tensions involving Israel, Gaza, Lebanon and Iran are increasing the risks for investors, particularly in the energy and commodities sectors, where further disruptions could affect global supply.

Markets could remain volatile in the short term. Investors need to keep an eye on monetary policy developments, the U.S. election and the impact of geopolitical tensions.  

Today’s challenges and issues present opportunities and risks in both the short and long terms. In this context, active management plays a crucial role because it gives portfolio managers the flexibility to navigate between immediate uncertainties and long-term investment opportunities.  

Discussions with a mutual fund advisor or a financial planner can help adjust your strategy to your personal goals, while taking your risk tolerance into account. In times of uncertainty, a long-term view is essential. In this way, you can take a step back from market fluctuations and gain a better understanding of the overall context. As history has often shown, sticking to a well-defined, long-term strategy is often the best way to achieve your financial goals.