'I think that central banks should exercise more patience'

While yesterday’s rate-hike announcement from the Bank of Canada wasn’t a surprise to one investment advisor, he doesn’t agree with the central bank’s decision to tighten monetary policy yet again.

“The pendulum can swing too far in either direction,” says Chad Larson, senior portfolio manager at MLD Wealth Management with CG Wealth Management. “And I think in this case, the BoC is making a mistake.”

Crushing the Canadian consumer

In its July rate hike announcement yesterday, the central bank said economic growth has been stronger than expected globally. In Canada, it highlighted the 5.8% consumption growth that showed in the first quarter in spite of the cumulative increases in interest rates since last year.

That strong consumption, Larson argues, was a product of the ebbing but continued reverberations of pent-up demand from the COVID pandemic. Coupled with other factors including enduring supply-chain constraints and productivity not quite returning to pre-COVID levels, he says Canadian consumption has certainly been strong and helped drive inflation – but he’s not expecting that status quo to persist.

“It takes consumers six to nine months on average to recognize they’ve gone through a change … When you look at retailers, things are slowing down in the stores. And we’re seeing more guidance from corporations in the consumer discretionary space expecting weaker sales,” Larson says. “I think that central banks should exercise more patience and consider their impact on consumer spending.”

Recent surveys suggest more Canadians are struggling under the increasing costs of debt. An analysis by the Canadian Housing and Mortgage Corporation found Canadians have the highest household debt levels among all G7 countries. In a recent survey of Canadians by the Angus Reid Institute, around two thirds identified debt as a source of stress, and the share of homeowners having difficulty with housing costs spiked from 34% in June last year to 45% this year.

While the recent decline in headline inflation from 4.4% in April to 3.4% in May – driven largely by a plunge in gas prices – is certainly encouraging, Larson notes mortgage interest costs have also shot up by almost 30%. As immigration stays strong and housing remains in scarce supply, Larson says the recent spate of rate hikes has only made housing affordability worse, putting further pressure on everyday Canadians’ budgets.

“To continue to crank up interest rates … always ends in the destruction of the consumer. And we’re in the early innings of that,” he says. “I expect things will be uglier in the fall, but I also anticipate markets will be on the other side of it as we look to an eventual recovery through 2024.”

Challenges for Canada-biased investors

While Canada has managed to avoid a hard landing, Statistics Canada reported real GDP remained flat in April after a 0.1% uptick in March, and its preliminary May estimate is for muted real economic growth of 0.4%. In announcing its July hike, the BoC said it is expecting economic growth to average roughly 1% through the second half of this year up to the first half of 2024, implying 1.8% real GDP growth in 2023 and 1.2% in 2024.

“Canada is a resource and services economy. We do well when GDP growth and consumer demand are strong, and I don’t think that’s the scenario we’re in,” Larson says. “We’ve seen a lot of pressure for the banking sector year-to-date, and energy has cooled off. So that’s going to be a bit challenging for Canadian investors who are largely domestically overweight.”

Larson anticipates inflation-hedge trades, including precious metals exposure, will continue to play a larger role in portfolios. Given the performance of the Canadian market so far this year, he also sees incredible value to be had even in counter-cyclical measurements.

“We’re staying the course with our core positioning,” he says. “I think if investors haven’t yet adjusted their portfolios, they’re probably already facing many difficulties.”

At MLD Wealth Management, Larson says they positioned portfolios in the NASDAQ earlier in the year as they expected a reversion to the mean and return of risk-on sentiment would benefit the tech-heavy index; with that market now up 33% year-to-date, they’ve removed that exposure to adopt a posture of liquidity. At the same time, they recently increased their allocation to gold as a safe-haven asset in uncertain times.

“These actions are part of a comprehensive approach, where we start at the top by reviewing our client's financial plans, and ensuring sufficient liquidity and cash flow to support them in the coming year,” he says. “Given the current market environment, I think it's important to be cautious and avoid making hasty selling decisions.”