Despite mixed macro picture, Canadian equities may see late-cycle tailwinds

The challenges to economic growth notwithstanding, one investment firm has warmed to domestic stocks

Despite mixed macro picture, Canadian equities may see late-cycle tailwinds

In its latest quarterly market outlook for Canada, Russell Investments sees the Canadian economy on a slower but stable growth path of GDP growth trending near 2% over the rest of the year. However, the firm acknowledged, lingering uncertainty around the North American Free Trade Agreement (NAFTA) negotiations could derail its forecast.

“With multiple deadlines missed, Mexican elections less than a month away, and the US mid-term elections in November, the odds of a compromise being reached this year are diminishing,” the firm noted, adding that the G-7 summit’s acrimonious ending adds to the already palpable tension surrounding the deliberations. “Ultimately, Canada stands to be at a severe disadvantage as more time passes without a resolution.”

The Bank of Canada projected a hawkish tone in its June policy announcement, noting that higher interest rates will be warranted to keep inflation in check. But the firm maintained that the NAFTA renegotiation gridlock has alarming implications, particularly as it could lead to multinational corporations passing on Canada as an investment destination. The potential upshot: a further diminution of the country’s long-term competitiveness from an inability to address capacity constraints that normally build up in the later stages of the business cycle.  

“Further complicating matters was the May employment report,” Russell added. The unemployment rate was maintained at 5.8%, and wages accelerated to current cycle highs at 3.9%. But the participation rate has trended lower since 2018 started, and monthly employment has fallen for two consecutive months, which hasn’t occurred since the end of 2014.

“While the BoC may be preparing the markets for its next move, we stand by our call for just one more interest rate hike in 2018 and potentially two in total over the next 12 months,” Russell said.

Despite the complicated macroeconomic picture, the firm said it was modestly positive on domestic equities, particularly in relation to the US. Between Feb. 1 and May 31, Canadian stocks have reportedly outperformed their US counterparts in about 90% of instances when returns were negative. Corporate earnings growth from Canadian firms, improving valuations, and improving momentum also contributed to its better-than-neutral stance.

“Late cycle support for commodities, Canadian equity underperformance, and improved valuation on a relative basis has warmed us to domestic equities, if not on an absolute basis, then on a relative basis,” the firm said. “Therefore, while we are neutral in absolute terms, we are modestly positive toward Canadian equities relative to the US.”