CIBC Year-End Update and 2024 Outlook – Economics and Portfolio Strategy

Roman Dubczak: Hello, everyone. I’m Roman Dubczak, Deputy Chair of CIBC Capital Markets. We’re here to help you keep connected to emerging trends and expert insights as you further grow your business. And I’m pleased to lead today’s Economic Outlook discussion at year end alongside Avery Shenfeld, CIBC’s Chief Economist, and Ian de Verteuil, Head of Portfolio Strategy. We have a terrific conversation ahead and I’ve been looking forward to it for quite a while. So let’s get started. Avery, perhaps we can kick off with you as you kind of summarize the key trends of 2023 and what some of the key themes will be for 2024.

Avery Shenfeld: Well, if we were to give this a title based on Shakespeare, it would be All’s Well That Ends Well, in the sense that I don’t think the year’s going to get off to a banner start. We know that here in Canada the economy is essentially already stalled and we don’t see any real relief from that for the next couple of quarters. So certainly a slow first half seems very likely for Canada. The US has been still growing quite quickly, but the Federal Reserve still seems determined to generate at least some sort of slowing as a part of getting inflation not only down to 2% but sustainably down to 2%, which is a bit of a difference. But that said, once we get past mid-year, I think we’re going to have the Bank of Canada fairly aggressively cutting interest rates. The economy is going to need that to pick up momentum into 2025 and the US, while they’re likely to lag behind on that because their economy is more resilient in the face of high rates, we certainly think that they’ll have cut rates before the end of 2024 and that positions the year to end with a little bit of momentum and certainly financial markets to end 2024 with a lot more optimism about what lies ahead for 2025. If there’s been some good news in recent months, it really has been that we’ve managed to take a huge bite out of inflation in the Us with virtually no economic damage along the way and while we still, as I said, think that we need some sort of slowing in the US economy to go that last mile and sustain 2% inflation, it’s certainly going to be a lot less painful than I think most market participants, particularly those who had called for recessions this past year, would have thought. So, it’s a rough start to the year, particularly here in Canada. It’s certainly a slow start. It’ll certainly be painful in some sectors. But the way capital markets work, if you end the year better than you started, that does generate some pretty good returns for investors.

Roman Dubczak: Okay. Thanks, Avery. Ian, we’ll also start off with you from a portfolio perspective, what’s your recap of the past year and how are we are we making money, so to speak?

 Ian de Verteuil: Sure, so first of all, we did make a fair amount of money in 2023. I would say two big surprises in ‘23: One was, I think the success of the, the high tech companies and actually producing just really outstanding, operational results, but also actually stock price performance. A lot of that was driven by the development of AI and the belief that that’s going to be something that really helps productivity across a variety of businesses. That’s one element of it. The other thing particularly well in 23 and as Avery mentioned, there were a lot of people expecting a fairly meaningful slowdown and we didn’t get it. And corporate earnings have been actually very strong this year when you look at the face of the inflation issue, but also interest rates. So I think those were the two things that really surprised -that ended up with ‘23 being a better year than I would have thought. I think as we look forward to ‘24, unfortunately, we stole a little bit. We’ve pre-booked a fair amount of the optimism, I would say. We certainly expect the earnings to actually be a bit better this year, but clearly the markets are still too optimistic on what the growth rates are. Believe it or not Roman, current estimates call for almost 12% earnings growth in an environment I think Avery you’re calling for not very much real GDP growth at all in North America, which would be surprising. So I think that’ll gradually get culled. So like Avery, I think first half of the year, we’re going to see earnings estimates get cut a bit. I think we’re going to have a bit of give back from the performance we stole in ‘23. But I would say we’re probably in the quite a bit better. So I would say for ‘24, we’re really looking for what I would call mid-single digit returns with, actually, dividends providing probably 20, 30% of the total returns in aggregate in ‘24.

Roman Dubczak: Okay. Yeah, thanks Ian. Avery, the US budget deficit is something that comes back every few days as it relates to, you know, headlines and whatnot. So it’s an immense number and getting larger all the time. That layered into an election cycle in the US, how do you think that impacts your view on the risks to our forecast, for example, and, you know, flexibility that basically the economy in the US has to continue to grow?

Avery Shenfeld: So the fact that there’s an election means they’re likely to kick this problem down the road again. But that said, it’s not actually that big a barrier to having a decent year in fixed income markets. The Treasury is financing more of that deficit at the frontend of the yield curve, where Fed rate cuts would ultimately have a bigger influence than borrowing requirements. That’s certainly a part of it. The high deficit is pretty much priced in to bond yields now. So of course, yes, longer term rates would be lower if we didn’t have this sort of overhang of heavy government borrowing, but it’s not fatal to the bond market in any one year. The US does at one point down the road have to address this budget imbalance, the demographics will push it higher over many decades and ultimately squeeze programs with higher interest costs, but this is a problem they’ve been kicking down the road and odds are they’ll kick it down the road for another year without really doing much damage to capital markets as a result of that.

Roman Dubczak: Okay. Well, speaking of capital markets Ian, we’re in a phase where some paradigms may shift. So, one in particular is always equity markets. You know, the low-vol strategy, the low-vol trading strategy in Canada was a winner for a long time, not so much in the last little while. What’s your view on that, that strategy, you know, prospectively and, or is there something else that’s going to probably move up in terms of strategies?

Ian de Verteuil:  Yeah, I think low-vol has been a winner in Canada for a variety of reasons. Our equity market is skewed towards resource names and a fair amount of volatile names. And, we talk about some stocks having a “lottery effect”. You know, people buy them because it may not work, but if it does work, what low-vol has done is kept investors out of that, generally speaking. Which in the long-term, if you’re a long-term equity investor, you want to generate intergenerational wealth that you can transfer. That’s how you do it is you own quality businesses over a long period of time. And low-vol has typically been very good at steering people to those companies. The issue that we faced, I think to some extent in ‘22 and ’23 were a couple of the of the stalwarts, a couple of the really traditional low-vol winners have had some specific issues. Great example with Telecom. So we had a very large M&A transaction in the telecommunications sector in Canada. And as a spin off to that, we had a fair amount of pricing issues, a bit of disruption that it caused in the market. So pricing got a little bit tilted in ‘23. So that particular sector had some problems. And the other long-term winner in low-volatility, is utilities. That business has become a bit more skewed towards renewables, which have had a very difficult year, largely because of inflation and as well rising the rising rates. and as well rising the rising rates. I would say Roman, as we look forward, particularly given Avery’s review of rates starting to come down, even if it’s in the second half of the year, those sectors should really start to pull together. We think the telecommunications pricing issue is largely settled and we would expect the rate issue to give low-vol another kick in ‘24.

Roman Dubczak: Okay. The other theme that seems to be in a state of flux, if you will, is ESG in the markets. What’s your view on that? Clearly, it’s lost momentum. Do you think it continues as a theme or…?

Ian de Verteuil: Yeah. I do. I do think it does. I think we need a redo on this particular issue. Yeah. Even, you know, Larry Fink talked about changing the terminology you exactly use because of the challenges that that came through with it. And the single biggest issue is this: when I say ESG, environmental, social and governance, it means different things to different people. So if I were to turn and tell you I’m running an ESG fund and it owns three times as much Russian oil and gas as it owns Canadian oil and gas, you might say, well, that’s crazy. But in reality, if your focus was only on carbon footprint, you might come to that particular conclusion. Right. But that’s not, when someone buys an ESG fund, that may not be what they think. So when I raise the point of the whole theme needing a rethink, it is, I believe the terminology is going to become more crisp. As such, if someone wants to buy a low carbon fund, they will do that. If someone wants to buy something where the governance fits very well with a variety of external metrics, they will buy that. But if you buy something that is “ESG”, or sustainable, you better be aware that it may not be doing exactly the things you want on the particular themes you’re most focused on. So I think it will still be an important element. And quite frankly, in a world where, whether it be carbon taxes cap and trade, where we do have climate change, I think particularly a lot of the environmental stuff will remain just the branding and how we structure it’s going to be different.

Roman Dubczak:  Yeah, no, thanks for that clarity. That’s, I would say, that’s probably a theme of the coming year is, clarity on, you know, what the different strategies are.

Ian de Verteuil: Yes, for sure.

Roman Dubczak: Avery, just back to you, China obviously looms large, has always loomed large, you know, in the context of the markets and our economy. And one of the big trends is de-globalization, but regardless, China still looms large on our economy. The economy seems to have slowed down to some extent or maybe perhaps moderated, you know, what’s your view on how the near-term, call it, the next year or so, looks for the impact it will have on the Canadian economy?

Avery Shenfeld: So the slowdown is sourced, of course, in their property market crashing some issues with them trying to get domestic demand going — Right. But also their exposure to the world’s economy through their exports. They had a little bit of a pickup in exports, but given the softness of global growth, that’s not a plus for them in the near-term. So a slower China is certainly part of the 2024 story. Ironically, it’s actually a bit of good news here. We’re in a ‘bad news is good news’ sort of world. China’s slowdown actually has been part of why goods inflation is coming down globally. Central banks will have more room to cut interest rates, particularly in Canada, I think, than the financial markets are currently pricing in, because we’re getting the benefit on the inflation side from a Chinese economy that’s weaker, from a Chinese currency that’s weaker, all of that is helping to hold down our import prices. Now, of course, China is an important export market for Canada, and that’s a negative for us. But one of the things that’s happening is China is losing market share to other low cost countries that export to the US, the likes of Mexico, Vietnam and so on. And to some extent, that’s a replacement for some of the global growth that China was contributing. And therefore, down the road may be a bit of a replacement for some of the demand for Canada’s resources that go into building capacity in some of these other countries. So it’s a negative on the export side, but maybe not as big a negative as it looks given that some of these other countries are gaining market share at China’s expense.

Roman Dubczak: Okay. What do you think the biggest risks are to your forecast in the coming year?

Avery Shenfeld: Well, we always think of wars and other shocks like that, but probably the biggest risks, is that either we, or the central banks, have, or will, miscalculate. So it’s a bit of an art form to decide how many rate hikes are enough. Both central banks and the Canada in the US, seemed to have decided that they’ve done enough, that’s a good thing, but there’s always a chance that, we don’t know it yet, but they overdid it, and that we end up with a harder landing than either the Fed or the Bank of Canada intended. Now there’s an out for that. They could cut interest rates earlier and offset some of that. But there’s again, always the risk that they miscalculated in 2024, wait too long to provide that interest rate relief, and therefore, even though we didn’t need a big recession to get inflation under control, we ended up having one unintendedly.

Roman Dubczak: Okay. So Ian, as it relates to the equity markets, two exciting drivers I guess in the last year -one was rates, and the second was the concentration of the mega caps, if you will, which are largely driven by the rate scenario as well, but they are performing, as you mentioned earlier. Do you think that going into 2024 and beyond, we see a rebalancing in a greater breadth to the market?

Ian de Verteuil: Yeah, I would… My word, I’d certainly hope so. It has been, you know, really… there’s two or three stocks in Canada that have driven the whole market higher. And particularly low-vol, a lot of the traditional winners in the Canadian equity market have lagged behind. In the US very similar. Interesting statistic: if you take the ten largest float stocks in the S&P 500, they now make up 32% of the market capitalization, which is the most concentrated it’s been. Even more so than in the tech bubble at the start of this century. So very highly concentrated. I would expect, and particularly because the valuations have expanded meaningfully on those stocks, I would expect a catch up. So we particularly like thinking about broadening outside of those names. I think I’m not brave enough to say that the tech will lag meaningfully. Evaluations are stretched for sure, no question about it. But ultimately the actual growth on many of these companies still looks relatively low risk, regardless of the environment, whether the central banks miss and over-tighten or not. I think that’s the case. So I do expect it to be better, particularly as earnings start to broaden out, particularly in the second half of the year, as we get the economy starting to move quite a bit better, as the rate issue has filtered through. So I do think we’ll start to see that. We’ll start to see, I think many of these the yield vehicles start to come back for us, particularly with rates coming down. Because, remember, that hurt them on the upside as well. So I think if you get rates starting to come back down, you start to get in broadening out. A lot of the yield sectors that have done quite poorly. So I do certainly expect to see broadening of the equity market in ‘24. Okay. Well, let’s hope.

Roman Dubczak: Thanks Ian. Avery, as well. Always one of my favourite conversations, and we could go on for a very long period of time and over the holiday season, perhaps we’ll have that opportunity to do so socially. So thanks, thanks again gentlemen, and to all of you joining us here today. Thank you for your business in the past year. Thank you for being good partners and wishing you the very best for a happy, healthy and safe holiday season. Thanks for joining us and hope to see you again soon.