- The Bank of Canada has held its policy interest rate at 5 per cent, where it has remained since July, in the absence of evidence that inflation is on a sustainable downward path
- Wages, shelter costs and measures of core inflation will likely need to fall before we see an initial interest rate cut
- High consumer prices and a slowing global economy have created opportunities in small-cap and micro-cap stocks, as investors look to preserve capital in less volatile instruments
The Bank of Canada (BoC) has held its policy interest rate at 5 per cent, where it has remained since July, in the absence of evidence that inflation is on a sustainable downward path.
The Consumer Price Index came in at 2.9 per cent in January 2024, down from 8.1 per cent in June 2022, driven primarily by a decline in gasoline prices and slower growth in grocery prices.
This trajectory is in line with previous statements from Bank of Canada Governor Tiff Macklem and his Governing Council, including the January 2024 interest rate announcement, about how the global economy is slowing, and that most advanced economies, including Canada, will reach their inflation targets by 2025.
Canadian consumers have reduced spending because of high prices, while business investment has contracted, leading to normalizing unemployment and job creation. This dynamic allowed the BoC to surmise that the economy is operating in “modest excess supply”, according to the January 2024 announcement, which is welcome news for the prospects for lower prices.
However, a number of factors are still contributing to the BoC’s wait-and-see stance when it comes to instituting its first interest rate cut:
- Wages remain above inflation at a 4-5 per cent gain year-over-year.
- Shelter costs, which include rent, mortgages and housing-related expenses, were up by 6.2 per cent in January 2024, making them the largest contributor to above-target inflation.
- Measures of core inflation, which allow the BoC to strip out the more volatile components of the Consumer Price Index, have yet to show sustained declines.
Until the tide turns on these factors, investors can expect continued downward pressure on stocks, especially small-caps and micro-caps with little to no revenue, whose assets are more likely to be overlooked by the broader market. Areas of interest include:
- Junior mining, where a broad-based disconnect between commodity and stock prices are offering investors a slew of entry points from 60 to more than 90 per cent below all-time-highs.
- Oil and gas, where robust reserves and profitable track records, like those of AKITA Drilling (TSX:AKT.A) and Saturn Oil & Gas (TSX:SOIL), are carrying on with no market recognition.
- Cannabis, where a lag in U.S. legalization and overproduction across legal markets has dwindled profit margins and tanked companies with market-leading positions, such as High Tide (TSXV:HITI) and Canopy Growth (TSX:WEED), which are in the best position to wait and restructure towards what the future holds.
Wherever the macroeconomic wind blows, remember its direction can serve as a short-term trade signal, but it is unreliable when it comes to predicting a stock’s long-term returns, given the multitude of variables affecting the economic cycle. If you’re investing for the long term, there is no substitute for building conviction in a company by delving into its news releases, corporate deck, financial results, and the market where it intends to generate shareholder value.
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