A Comment -- General Comments From an Expert (A Commentary)

Declining inflation, which encourages central banks to cut rates. Yet still a growing economy and very strong employment numbers. Putting that all together is like rocket fuel for bonds, and for the stock market. Market breadth has widened beyond the Mag 7 to other sectors.

Very cautious on anything driven by the consumer. Consumer in Canada has really slowed down, unemployment is ticking up. 

Talk of tariffs by Trump is more bark than bite; last time he was elected, not much happened. Trump is certainly going after cheap exports from China. That said, his firm's equity portfolio in Canada is fairly immune to any tariffs -- not much exposure to exporters or resources. Most of the businesses are domestic or have manufacturing within the US, or they sell goods exempt from tariffs (such as FDA-approved products). Lots of his investments are in service companies, such as IT or engineering. 

Cash hoards in money market funds are going to come out, go into stocks and bonds. Corporate bonds still have some very attractive yields, with the average in his fund being 5.4% -- still well above inflation even on an after-tax basis. Preferred shares have also been on a rip the last 2 years.

Money will find its way to Canadian stocks. The loonie is quite washed out. The additional 50 bps rate cut today didn't cause the forex rate to move, so it was already baked in. Loonie's basing here, and US stocks are expensive. Better value in Canada, US stocks have been quite frothy. Every country has been in a funk except the US, so money should move into more reasonably priced markets.

Yes, lower rates do encourage home buying and investments in real estate. So the sector should perk up, but it won't be as liquid as stocks and not for everybody.

He doesn't own any REITs. Many have external management, which he doesn't like. At different times, he has been in and out of CAR.UN and BEI.UN. Sees better value elsewhere, you have to pick your spots, and it's really a question of timing. They can be a great trade, as they got crushed when rates were rising.

The Santa Claus rally is a reliable pattern, but doesn't mean stocks will rally for ALL of December. Last December, the S&P went straight up, but the VIX bottomed on Dec. 12--a sign of rising fear--which led to the S&P selling on Dec. 20 after the VIX climbed. In 2022, the VIX bottomed on Dec. 2 right after the S&P peaked, then the S&P headed down for the rest of the month. For 2024, the VIX has not been sending any warning signals--when the S&P goes up, the VIX goes down. The big exception are the weeks leading up to the election, Oct-Nov, when the S&P went sideways and the VIX remained sideways too. Very unusual. In the past month, the S&P climbed higher while the VIX tanked--a bull market. But the VIX bottomed on Dec. 6 and has since bounced. Sebastian though sees no red flags in the chart (yet), BUT the S&P is sitting beneath its all-time highs while the VIX is up nearly a point since Friday. Today, the S&P erased Monday-Tuesday's losses, but the VIX has not erased its gains, because banks and hedge funds are buying options to protect against volatility--the big boys are getting nervous. If this patterns endure tomorrow, we might be at the start of the VIX and the S&P move in unison, and this usually mean the S&P is headed for a serious sell-off. This could follow Dec. 2023's pattern of roaring a week before Xmas, pulled back hard, then rallied through Xmas and New Year's. Bottom line: the Santa Claus Rally is never guaranteed so don't be complacent.

Market Update:

The TSE Index was up 6.16% in the month of November, up 23.93% YTD and 26.73% over the past year. Canadian GDP was up 0.30% in the fourth quarter of 2024 and 2.00% for the full year; in the USA the GDP was up 2.80% in the fourth quarter and 2.70% for the full year. The Canadian inflation rate was up 2% annually and the US inflation rate was up 2.60% annually in November 2024. With this background, the following Table presents the highest and lowest performers for the month of November 2024.
Unlock Premium - Try 5i Free

There's value outside North America as the valuation gap between US stocks and ex-US wider than ever. Add to that the strong USD, so those foreign companies are cheap. He likes Japan, UK, and Europe, though many do business in the US. 2025 Canadian outlook: bullish because of further interest rate cuts, and Canada is dividend-driven.

He doesn't like the sector and he expects natural gas prices to trade off a little. Wait and see with energy as a whole. Nat gas stocks are too high given the nat gas price, and he expects a pullback and opportunities.

Not recommended. Preferreds don't do well during rising or even declining rates. In Canada now, rates are low around 3% for a 10-year bond. He suggests instead a simple laddered portfolio of bonds, 1-5 years, plus a couple government bonds and some high-quality corporates. Hold and don't trade. It will buffer volatility. 

The end of the Assad regime in Syria will impact North Americans through oil prices and energy stocks. We saw an initial uptick in futures and ultimately this will translate into inflation. Also, Trump wants to pump, baby, pump oil, which will lead to a supply offset. He read that because the US is the top producer, there's already underinvestment going forward; in a few years, US production numbers will come off due to this under-investment. Tech: we're in the early stages of the battle for tech supremacy and semis are in the middle of it. China: given Trump's rhetoric, expect volatility next year in emerging markets.

That doesn't exist. The premium derives from volatility, but there's less volatility in shorter-term bonds, because the price doesn't fluctuate much. However, in the US, you can buy an IEI, which is a bond note that gives 3-7-year exposure and you can't write your own calls to get the additional premium.

Minor exposure and limited impact. Foreign investment in Canada, if that money leaves (due to a weaker investment climate here), it will have little impact on Canadian markets and multiples; the flows are not that big.

The Bank of Canada this week is expected to cut interest rates again, likely by 50 points. He expect by the end of 2025 the BOC will cut only another 50-75 points for all of 2025. Next week, the US Fed will cut too, though they are cutting less aggressively, because the US is seeing an uptick in inflation there, though Canada will. If US inflation data this week is hotter than expected, the Fed will pause. The BOC will cut because the Canadian unemployment rate is now at 6.8% because the participation rate has ticked up. Back up to 2023 through much of 2024, Canada saw a decline in that participation rate. He estimates that if the participation rate returns to normal, which is higher, then the unemployment rate will hit 8%, which is the 50-year average. We're quickly returning to those levels. Employment is driving the BOC decision. Therefore, the BOC will seriously slow down rate cuts in 2025. Also, expect more weakness in the CAD. In the US, inflation this week could come in hotter than expected, which will limit the US Fed's rate cuts.

The market is complacent, taking its gains for granted, which is something that rarely ends well. The VIX is very low, about 14. He sees worrying signs in the junk bond spreads, based on the ICE BOFA US high-yield index option-adjusted spread. The spread between treasuries and junk bonds has fallen to its lowest level in 5 years, even lower than the spec mania of 2020-1, as low as summer 2007 (not good). He predicts that at the Dec. 18 Fed meeting that if the Fed talks DOWN the number of interest rate cuts for 2025, this will cause a huge sell-off in stocks--which may be buyable.

Company Highlight: VersaBank (VBNK)

VersaBank (VBNK) is a Canadian-based, digital-only bank focused on specialized lending and deposit services. Established as one of the first fully digital banks in Canada, it operates without physical branches, leveraging technology to keep overhead costs low and streamline services for niche markets, including point-of-sale (POS) financing and commercial real estate lending. It mostly operates in Canada, but has recently expanded some services into the US. 

Its stock price has recently seen strong momentum, up 58% year-to-date, and 125% on a one-year basis. It pays a small yield (0.4%), but both sales and earnings growth are expected to be strong in FY2025 and FY2026. Its historical growth rates have been robust, with a five-year sales and earnings CAGR of 16% and 19%, respectively. Net profit margins are expanding and with a market cap of $595.7 million and a reasonable valuation of 11.4X forward earnings, we think VBNK looks interesting here. 

We can see that its net profits have really taken off over the past couple of years, and its outlook is increasingly positive. It has ongoing plans to expand its POS financing offerings in North America, and its cybersecurity segment, DRT cyber, is also expected to see growth in the coming years. 
Unlock Premium - Try 5i Free