Dominique Lapointe, senior economist at Laurentian Bank Securities, believes stock markets will continue to be resilient despite rising geopolitical turmoil.Supplied
Despite rising geopolitical turmoil and plunging investor sentiment, major North American stock markets are still near levels seen before the Russian invasion of Ukraine. While intraday volatility has increased, indexes are holding their ground – at least for now.
Dominique Lapointe, senior economist at Laurentian Bank Securities, believes stock markets will continue to be resilient, expecting major North American indexes to reach record levels later this year.
In an interview with The Globe and Mail this week, Mr. Lapointe shared his perspectives on major market drivers and how investors can protect their portfolios during these turbulent times. He wanted to emphasize that investors should talk to their personal advisers before investing.
Several weeks ago, you published an economic outlook and strategy report in which you forecast the S&P/TSX Composite Index to exit the year at 22,564 and the S&P 500 Index to hit 5,000 by year-end. Underlying this market strength you noted strong economic conditions and solid earnings growth with Canadian real GDP forecast to grow 3.5 per cent in 2022 and 3 per cent in 2023, and earnings growth of 21 per cent anticipated this year. Also positive, you anticipated inflation to decline to 2.5 per cent by mid-2023. How may the Ukraine invasion affect these forecasts?
It’s really hard to say at this point. I think it’s hard to know where Russia is going, what their intentions are, and how are they going to react to the sanctions.
Given what we know so far, it’s not a big impact on Canadian growth or North American growth, it’s more about European growth being impacted.
We were expecting inflation to come down starting in the first quarter but now, with this war, that delays that normalization. We’ve seen oil above US$100, natural gas will probably increase a bit more, and agricultural prices are rising. Russia and Ukraine are big producers of wheat and also aluminum, so rising prices of these materials will feed into inflation. We also see transport costs rising already because naval routes are being disrupted. Inflation, for sure, is being revised up.
I’m surprised how sanguine the stock market reaction has been. If I consider the scenario where there will be some decline in tensions at some point, then I am not too worried about the stock market. I don’t think I am going to change my targets right now on the TSX and S&P 500, same thing with the earning growth forecast. If anything, look at the energy and materials sectors – they are going to be revised up – so I am still comfortable with my earnings forecast.
In your recent outlook report, you called for six rate hikes by the Bank of Canada, taking the overnight rate up to 1.75 per cent by the first quarter of 2023, and then you have no further rate hikes forecast. Has this outlook changed given your higher inflation expectations and the Russia-Ukraine crisis?
We think what is most likely going to happen is that they do three back-to-back hikes and then a brief pause during the middle of the year to assess the situation. Then, the economy can probably sustain a few more hikes, which would lead us to a total of six. Based on where we think inflation and the economy will be, 1.75 per cent is likely a rate at which the economy can still grow and full employment can be sustained. I don’t think I will change this forecast.
I don’t see the Bank of Canada raising rates faster because they are facing higher inflation from the war. On the other hand, I wouldn’t think they would slow down the pace of hiking. What I think they are going to do is flag it in the statement that they are monitoring inflation and it’s a considerable source of risk.
Amidst this market volatility, for investors with a one- to three-month investment horizon, are there areas of the market where one can be opportunistic?
The current situation, while tragic at the human level, reinforces our bullish call for energy stocks in the near term. In the medium term, we continue to think energy stocks will perform well. Canadian companies are trying to ramp up production and have big plans to expand. We are still bullish on high oil prices, higher production volume and investment.
On a tactical basis, I think commodities will go up. Maybe I would go to an overweight for materials in the short run but a lot is already priced in at this point. With bonds, yields seem to be coming down, so I would probably recommend an overweight in government bonds. This seems to be something that could be a good hedge in the near term, same thing with gold.
Is an elevated price of oil one reason why you forecast the Canadian dollar to steadily climb to 82 US cents in the fourth quarter and 83 US cents in 2023?
If you look at the Canadian dollar, the correlation with oil right now is low. The Canadian dollar is trading below 80 cents with oil near US$100 a barrel. Go back 10 years and that level of oil was consistent with the Canadian dollar above 90 cents, so that correlation has weakened.
One reason why we see a minor increase is when all rate hikes are priced in, we don’t see a big differential between U.S. yields and Canadian bond yields. We also think that when tensions ease, the U.S. dollar has more room to fall due to less volatility in the market and less risk aversion. If you decompose what is moving the Canadian dollar, non-energy commodity prices also matter and we think they are going to stay elevated and that should increase the dollar to a level a little higher than where it is now.
Looking out over the next 12 to 18 months, you are recommending financials and industrials.
Those sectors that you pointed out are linked to value. Within value, we recommend quality, companies with good earnings and sales prospects.
The framework starts from value, and within value stocks, you’d want to own small caps. Over all, the returns of value and small-caps stocks are good when you have strong economic growth. Government spending is also supportive for value stocks. In Canada, I think the deficit for this year is forecast to be around $60-billion, so it’s still a sizable deficit.
In recent days, we’ve seen bitcoin rebound as further sanctions have been imposed on Russia. What do you make of the extreme moves higher and lower in cryptocurrencies?
I just want to be clear, it’s really risky and people should be really careful when they do invest in cryptocurrencies, really try to research what is the project and what is the token and who they are doing business with. First, be very careful. Second, understand that a lot is, in our opinion, being driven by speculation. For example, bitcoin, the first thesis was that it was supposed to be a store of value in a way of trading and doing commerce. That hasn’t happened yet.
Right now, the narrative with crypto is changing. I don’t know if you’ve read or heard about Web3, the next generation of the internet possibly supported by blockchain technology. That is the one new narrative for crypto and we think there is some interesting value in there. For instance, with video games there’s a lot of interest for non-fungible tokens, so there are pockets of interesting innovation that could support crypto.
Why we think it’s interesting right now is because we’ve had such huge speculation drive bitcoin so high and now we’ve had this huge correction. If we start to trade more on fundamentals and those little pockets of interesting innovation that are actually driving the value of those cryptocurrencies, then it’s more interesting than trading on mere speculation and meme investing.
This interview has been edited and condensed.
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