Sadiq Adatia, chief investment officer at BMO Global Asset ManagementSupplied
Heightened bullish sentiment has helped lift the S&P/TSX Composite Index nearly 2,000 points, or about 8 per cent, since Sept. 6. Today, the Bank of Canada slashed the overnight rate by half a percentage point, providing a tailwind for stocks.
To gain a sense on whether the bull run can continue and what sectors may lead the market higher, The Globe and Mail recently spoke with Sadiq Adatia, chief investment officer at BMO Global Asset Management for a two-part interview. Part one, featured below, focuses on his outlook for the S&P/TSX Composite Index and the slumping Canadian dollar. In part two of this interview later this week, Mr. Adatia shares his perspectives on potential opportunities and risks he sees in U.S. stock markets.
Easing monetary policy conditions are constructive for stock markets and the Bank of Canada is clearly on the path of continued rate cuts. So why do you have an underweight recommendation on Canadian equities?
The Bank of Canada has started the process of cutting interest rates. We see that continuing for the foreseeable future.
Part of the reason why the Bank of Canada went before the U.S. Federal Reserve did was because Canada’s economy is struggling. The unemployment rate is higher. When you look at what is going on with consumer spending, it’s a little bit more difficult. Canadians are going to be hit harder with renewals to refinance their mortgages. And then of course, Canadians have a higher amount of debt, which restrains them from being able to spend. And given that we’ve had high rates for quite a bit of time that debt multiplied by a higher interest rate really eats into the amount that consumers can spend on the economy. So, we don’t like Canada as much from an investment perspective and we see better opportunities in the United States.
You see lower economic growth in Canada as well as lower corporate earnings growth then?
We like U.S. corporate earnings a lot better. If you think about the biggest earnings right now, anywhere in the world, are tied to some of the big technology companies and they’re not in Canada, they are in the United States so that’s what’s driving a lot of the strength in earnings.
According to Bloomberg, earnings are currently expected to grow approximately 16 per cent next year for the S&P/TSX Composite Index. How does your earnings outlook for 2025 compare to this double-digit earnings growth estimate?
I think because expectations are not high generally on the market, I think the earnings are fair and reasonable.
A couple of segments I think are important to note here. The energy sector will depend on demand. If countries like China get their growth coming back, then that could surprise to the upside. We could see earnings do much better.
If we see continuation of the Bank of Canada cuts that will start to help consumers a little bit more and they could spend a bit more. So therefore, we could still see some upside there as well too.
Can provide an overview of the sectors you are bullish on in the S&P/TSX Composite Index?
We definitely like the financials sector. It’s an area that we’re overweight in and the rationale there is pretty good. I think when you look at Canadian financials, there’s a bit of dominance here, we don’t have as much competition as we see in the U.S. They’ve got generally healthy balance sheets and strong dividends and the propensity for dividends to continue to go higher as well. Canadian banks have also looked outside Canada to grow their businesses and areas like the U.S. have been much stronger and therefore there is some upside potential coming through on that front as well. That’s true with insurance companies and also asset management companies where the ability to grow is pretty good.
When I look at the energy sector, I would say US$70 to US$80 a barrel is fair value to us. We’re neutral on energy because we’re sitting in that US$70 to US$80 range but we would be buyers if we drop below US$70 and would be sellers if we got closer to US$85 or US$90.
An area where I think we should look a little bit more carefully at is the mining sector. I think that’s an area that still has room to go higher.
And if you think about the consumer staples side, I think people are going to be a little bit more conscious on how they spend money and that’s an area that I think will have a little bit more interest coming through, particularly when it comes and relates to Canada’s economy. Consumers are not going to spend as much on discretionary items because they have higher debt, and they have still high interest rates. So, what they’re going to do is spend money on necessities, things they need to have versus things they would like to have.
Within the mining sector, you lowered your gold outlook but still have a slight overweight call. Can you expand on why you believe gold is poised for further gains?
We’ve seen are three things that are very supportive for gold.
One is even though the broader global economy has been decent and we’ve seen a great stock market run, there’s still a lot of people who are expecting markets to decline, expecting the consumer to weaken and expecting more risks along the way, we’ve had geopolitical tensions along the way, so gold has been a good way for people to think if something were to go wrong, gold would hold up quite well. So that’s one reason why it’s done well.
The second reason is people have been looking for alternative currencies from the U.S. dollar. China is a good example of that. They’ve been adding more gold to its reserves versus the U.S. dollar and that’s driven up demand and driven up the price of gold at the same time. So that’s the second reason why we’ve seen gold do well.
The third I would say is when people were looking at things that could have a lower correlation with the equity markets, traditionally, they’ve gone to fixed income. But over the last two years, what we’ve seen is fixed income and stocks have been a lot more highly correlated than they should otherwise be. So, fixed income has not acted as a protection when equity markets sell off. People have now gravitated a bit more to gold because it does provide that protection.
Those are three real reasons why we think it can continue to do well.
Are there other commodities that look attractive to you?
Silver is the other one that could get a little bit of positivity there, but we prefer gold over silver.
What are your return expectations for the S&P/TSX Composite Index in 2025?
I think the TSX will have a little bit more of a challenging time. I see probably somewhere between zero and a 3 per cent return on the TSX.
And it’s tied to the fact that I think consumers are going to have an overhang of higher interest rates and mortgage renewals, when mortgages get renewed, they’re paying a lot more than they were paying previously, which is going to cut into consumer spending. We’re seeing the unemployment rate go up a little bit. And there’s still going to be the impact that people will end up seeing as the economy continues to weaken a little bit. So, put that together, I don’t see a lot of upside on Canada. I think you are going to roughly get the dividend yield you get on stocks, which is why we like Canadian financials because the dividends are pretty healthy and because they have been beaten up a little bit, in some areas, so there’s room for upside potential.
Where do you see opportunities in the fixed income market?
I think you want to own fixed income over cash.
We like quality bonds or investment grade, which we think is going to outperform high yield given that the economy is slowing down a little bit. I don’t think the yield that you’re getting in high yield now compensates for potential risks.
Over recent weeks, the Canadian dollar has sharply declined relative to the U.S. dollar. What are your thoughts on the Canadian dollar?
I think the Canadian dollar heads a little lower.
It’s actually held up relatively well for most of the year despite the fact that Canada started cutting rates faster. But I do think you’re going to see the Canadian dollar probably flirt with that 70 cent or 71 cent level. As rates come down, you get a higher rate outside of Canada, and money will start moving there, and growth is higher in other geographies. So, I do think you’re going to see a little weakness in the Canadian dollar over the next three to six months.
I think you start to see some momentum backing the Canadian dollar when the U.S. Federal Reserve starts to cut more aggressively, and you start to see the Bank of Canada potentially pause or slow down a little bit. That’s when I think you start to see a reversal in the Canadian dollar.
But for now, I think you see some more weakness.