Despite concerns about global economic headwinds, the Bank of Canada’s successful efforts to curb inflation is capturing the attention of institutional investors, says Kathrin Forrest, a Toronto-based equity investment specialist at Capital Group Inc.
“It’s surprised market participants,” says Forrest, referring to the central bank’s Oct. 26 decision to increase interest rates for the sixth time this year. “When you look at how equity and fixed income markets responded, it was well received. Inflation is still way above the target range so there’s an ongoing effort to raise the policy rate.”
The move, which raised the overnight rate to 3.75 per cent, is part of an ongoing strategy to curb inflation to between two and three per cent. According to the bank, the cumulative effect of these hikes is having its intended impact on inflation, though these efforts have also been aided by a global demand slowdown that’s cooling import prices. Since reaching an 8.1 per cent zenith mid-year, inflation cooled to 6.9 per cent by the end of the third quarter, according to Statistics Canada.
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After the announcement, the S&P/TSX rose 6.5 per cent in less than two weeks, despite central bank projections showing Canada’s gross domestic product will grow by just one per cent in 2023 and two per cent in 2024. During the same period, the S&P Canada aggregate bond index rose 3.3 per cent.
According to Forrest, the immediate market reaction was driven by the prospect that price-to-earnings ratios would improve if interest rates pressures moderated. “In Canada, the equity markets have compared well to global ones. The TSX [composite index] is down six per cent on a year-over-year basis. A lot of the negative return impact came from valuations, which were lowered by interest rate rises. With valuations we see today, Canadian equities look relatively cheap on the surface although we have not seen much overall adjustment in earnings expectations. With that, bottom-up selection is an important consideration.”
The central bank also warned that higher-than-normal interest rates will continue to have a marked impact on the economy in the coming months. “Economic growth is expected to stall through the end of this year and the first half of next year as the effects of higher interest rates spread through the economy.”
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Some parts of the Canadian market look well-positioned for long-term growth, adds Forrest. “There’s broad economic headwinds but, despite that, we see opportunities. We don’t need to invest in the market as a whole, but some companies will do well in the current environment.”
The news comes as many Canadian defined benefit pension plans seek to recover from three bruising quarters. In Ontario, where the majority of the country’s DB plans are domiciled, the average solvency ratio dipped from 110 per cent as at June 30 to 109 per cent as at Sept. 30, according to a new report from the Financial Services Regulatory Authority of Ontario.
The decrease was attributed to poor returns, with average plan assets dropping 0.4 per cent. On an annual basis, average DB plan assets were down 16.3 per cent, though these losses were partially mitigated by rising discount rates leading to decreasing liabilities.
According to Forrest, various companies particularly within the energy and materials sectors may be well positioned in the coming years.”In Canada, we’ve seen opportunities in energy and materials. This has less to do with the current gas crisis and more to do with the transition away from fossil fuels. In addition, increased electrification presents long-term structural growth opportunities in materials such as copper.”
Read: Ontario DB pension plans’ projected solvency dipped in Q2: FSRA