Inflation is slowing in Canada, but where does that leave markets?

Portfolio managers weigh in on outlooks for stocks, bonds after Canada reports slower inflation rate

Inflation is slowing in Canada, but where does that leave markets?

Canada’s inflation rate came in lower than expected on Tuesday. Statistics Canada reported that the consumer price index rose 3.8%, slower than the median estimate found in a Bloomberg survey of economists. With so much of market volatility over the past two years driven by inflation rates, and reactive rate increases, the slowdown may be a welcome sign for markets.

Three portfolio managers weighed in on what this latest data could mean for the Canadian economy and Canadian investors. Paul Marcogliese and Grant Connor, SVP & PM and VP & PM for fixed income at CI Global Asset Management respectively, weighed in on where this news leaves fixed income markets and the possibilities for Canada’s economy. Wolfgang Klein, senior PM and senior wealth advisor at Canaccord Genuity Wealth Management, offered his outlook for equity markets and client portfolios in a difficult economic environment.

“The bank of Canada doesn’t have to keep hitting the brakes with higher rates at this point,” Marcogliese says. “That should be a slight positive for the economy, but the effects of the rate hikes they’ve already done are still intentionally causing an economic slowdown to take place. It’s one print that we’re not drawing too many solid lines on to have an effect, but it is a positive that should be a comfort [to the BoC] that they can pause rate hikes going forward.”

Marcogliese and Connor aren’t drawing major trendlines from this report because of a notable drop in the energy component of CPI. Energy is an inherently volatile piece of inflation that can skew CPI in unexpected directions up or down. They attribute some of the slowdown in food price increases in this CPI print, for example, to lower energy prices.

From an investment perspective, Marcogliese and Connor believe that the bond markets “have not been this attractive for a very long time.” They admit that bonds have had three poor years of performance, but their significantly reduced valuations give an opportunity for investors to enter the fixed income market. The only caveat, for now, is that investors and advisors may have to ride out the continued short-term volatility we are seeing in bonds. They think those with a longer time horizon may see opportunities in that space.

Wolfgang Klein has been underweight bonds for 20 years. He now thinks that bonds are worth the 40% allocation that a balanced 60/40 portfolio allocation demands. Klein’s focus, however, remains on equities and he believes that in a swirl of inflation and rate hikes we are currently sitting in a stock-picker’s market. 

“Expensive stocks look better than cheap stocks,” Klein says. “It might be counterintuitive, and it’s something that retail doesn’t get their head around, but that’s what’s working. The more expensive stock is better quality, it’s a leader. Don’t waste time trying to pick up cigarette butts.”

Klein cites the outperformance of large-cap tech over equity markets so far this year as evidence for his approach. He notes that the S&P 500 equal weight index is barely positive YTD. The S&P small cap and mid-cap indexes are negative, while the NASDAQ is positive to the tune of around 30% — albeit after taking significant losses in 2022. Klein thinks that tech stocks can be treated like a long bond, with investments made in future profitability of currently unprofitable companies. He thinks a savvy advisor can capture value by looking beyond just the FANG stocks or the “magnificent seven.” He thinks cybersecurity companies, for example, represent both attractive valuations and growth prospects.

As advisors try to capture opportunity and make sense of datapoints like this CPI print, Klein argues they need to be refocusing on their clients’ plans. The news of the day, he says, is irrelevant in the face of their plan. If their clients are positioned to capture value from the smaller set of stocks that Klein expects to rise in value, he thinks they can be assured of their advisor’s value.

Marcogliese and Connor are also trying to look past headlines to find trendlines. When looking for clarity on the seemingly endless debate of an economic hard or soft landing, they’re paying close attention to labour markets and corporate profit margins. They think that advisors can use those datapoints to speak to their clients and steer them away from noise that can provoke anxiety and prompt bad investor behaviour.

“There’s a lot of economic data that is very negative and very positive and it's creating whiplash in the fixed income market,” Marcogliese says “We are trying to avoid getting caught up in that noise. We need to keep making sure that we're looking through it to the more prominent indications of what the fixed income returns can be.”