What to expect from Canadian stocks in 2024

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It's been a choppy ride for the TSX Composite Index. But according to our feature guest today, it's important for investors not to get overly optimistic. What we've seen recently are overly pessimistic about some of the pullbacks we've seen. And we, of course, got another year ahead of us just on the doorstep.

Joining us now to discuss-- Michael O'Brien, managing director and head of the Core Canadian Equity Team at TD Asset Management. Great to have you back on the show, Michael.

Hey. Great to be here, always.

I love that framing of don't get too optimistic, don't get too pessimistic, because I suffer from the same thing where I can get a little narrow in my vision, like, wow, what a month we had in November. But ooh, what a month we had in October. It's been a choppy, rangebound TSX. What are we seeing? And what should we be mindful of?

And by the way, I think that's the therapy I give to myself. So if anybody else wants it, that's great. But when you get into these types of periods where-- these violent moves, it can be pretty disorienting. You forget those first principles around valuation and momentum.

And so it's fascinating when you look. Obviously, November-- it was a huge month, a huge month. But like you say, September, October were really pretty dark times. It just never ceases to amaze me the swings in sentiment.

And so it's not so much that fundamentals were detached from those moves. It was more that when sentiment gets on board, things can get amplified or taken to extremes. And that's where-- I think that's where we need to step back and say, wait a second, let's put this in perspective.

And so despite all these ups and downs, when you really step back, these markets have been rangebound for the last couple of years. You look at the TSX. We peaked-- I think it was in April of 2022. So this is almost two years now. The S&P peaked a little bit before that in January of 2022. So for the better part of two years, you've had this churning, sideways market.

And I think when you look at it, it makes sense because that coincided with the beginning of the rate hike cycles both in Canada and the US. And so it does make sense when you think of it in that concept, in that framework. This rangebound trading is because we've all been trying to figure out how much work do the central banks have to do, how are the economies going to respond, how are earnings going to respond.

And it's still not quite clear what the outcome is. But I think as we head into 2024, we're a little bit closer to that conclusion. But it's just-- I think it's always helpful-- I find it always helpful just to step back and try to put it in that bigger picture perspective that, look, for all the excitement, all the running we've been doing, we're all out of breath. We haven't gotten anywhere in two years. So it's just important to put that in perspective.

Up and down, up and down. So as we head into next year, there's two ideas that are in my mind just from having gone through reports and thinking what economists are saying, what strategists are saying-- that we're probably going to see rate cuts from the central banks, including ours, maybe even as early as the spring from the Bank of Canada. But we're also going to see a slowing economy. If I put those two thoughts together in my head, what am I supposed to think about the markets? What about the TSX?

When I look at it-- and you're right. Obviously, investors-- a big part of the move that we've seen in recent weeks has been investors hoping, believing, speculating that rate cuts are going to come. But at the same time, they're wishing for those rate cuts without the thing that would typically trigger a rate cut, which is a really nasty downturn, which would impact company earnings and impact employment.

So there are a little-- some inconsistencies, I would say, just in terms of how the market necessarily is looking at that. But bigger picture, clearly, the viewpoint is that rate hikes are behind us. And it's a question of if and when rate cuts will arrive.

I would look at that and say, in the Canadian context, I suspect that there will be rate cuts by the time we get to the middle of the year. And the reason I think that is because I think the economy needs those. I think it's becoming more clear that the Canadian economy is slowing.

And when you look forward, there are some pretty obvious headwinds on the horizon that we're going to have to work through. It doesn't mean that it's all doom and gloom. But realistically, I think the outlook for 2024 has to be a pretty sober one, where we would expect in Canada to have pretty sluggish growth. By extension, you shouldn't expect a real blowout earnings year for the Canadian companies, by and large. This is going to be one of just churning through a lot of headwinds.

Let's talk about one sector in particular I know you want to illustrate in terms of what we could expect to see in this kind of environment, what's happening with the banks. We've just been through banks earnings season. They've been warning us they're getting ready for a bit tougher time next year.

Yeah. And so again, this is one of those ones-- you want to have a balanced perspective on this because on the one hand, the bank earnings numbers were a bit disappointing. It was a mixed bag, I guess you would describe it. And clearly, what we saw was continued increase in PCLs, or loan losses, not to alarming levels. But the trend has been higher.

We're seeing more pressure on loan growth. Loan growth is slowing. We're also seeing pressure on capital levels. Just people don't want to let their guards down. And so all of those things are conspiring to keep pressure on the earnings outlook.

So like I said, about, I think, three of the six banks beat expectations. Three of the six missed. The more important thing is earnings estimates for the calendar 2024 and fiscal 2024 are still coming down. They're still being reduced. And expectations now are pretty modest for the year.

On the other hand, though, when you look at the way the banks have been trading and some of the sentiment around them, they're trading, a lot of them, below 10 times earnings, 5%-ish type dividend yields. They're pricing in a lot of negativity.

And so when you go through and say, is that well founded in the results we just saw. The areas that you would typically get most alarmed about, things like how is credit unfolding, are they in a position where they have to actually raise capital or they're offside on capital-- and those boxes-- they still look very solid. The credit picture, by and large, is holding together, I would say, better than the bears would have thought.

Credit or capital-wise, obviously, people want to guard their capital cautiously in these types of environments. But they're all sitting there extremely well capitalized. So those real tail risk downside scenarios don't seem to be in the cards at all right now. So that's, to me, quite reassuring.

So like I say, it wasn't a great earnings season for the banks. The outlook isn't great. But it's not terrible, either. So again, more of that churning sideways market-- that might continue for a little while with the banks in particular until people get a stronger view that the worst is behind them.

Could that set us up-- now I'm going to be probably too optimistic. You said don't be too optimistic, don't be too pessimistic heading into next year.

We don't have to be all sour.

But could that set us up in the sense that if things-- if we stick the perfect landing next year-- the economy doesn't crash and the Bank of Canada is able to ease off of restrictive policy and we get that perfect soft landing-- could that mean better things than perhaps we're expecting for the TSX? The financial's such a heavy weighting in the index.

And the short answer is yes. If we get a soft landing, if inflation comes down without excessive job losses, if economic growth bottoms at a reasonable level and then begins to tick higher, if interest rates are cut by the central bank, then yes, there's absolutely upside in the market. The question we always have to ask ourselves is, how realistic is that set of outcomes?

And so it's not impossible. But it's probably not the most likely outcome. There will probably be one or two wheels that fall off at some point. And you have to put them back on.

And so that's when I frame it up like it's-- the markets are at a point where in the Canadian context, valuations aren't demanding. Valuations aren't really the problem. They're reflecting cautious expectations. It's just the most likely outcome, at least with the data we have today, is that it probably will be a difficult year next year in terms of earnings growth. It probably will be a difficult period of time for the Canadian economy, for the Canadian consumer, for those Canadian households that see mortgage renewals coming in 2024, 2025, 2026 that will squeeze the cash flow they have available to spend on other things-- to spend on entertainment, groceries, new cars.

So all of those things suggest that we're probably into a period where growth will be a bit sluggish for a while. But if we get one of those pleasant surprises-- and the market never ceases to humble us. The market never ceases to surprise us. If we get one of those outcomes, then absolutely there's upside because the markets are not, at least in the Canadian context-- the markets are not reflecting an exuberant outcome. [AUDIO LOGO]

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