'At the current environment we're avoiding the dreaded r-word, recession": Headland

Key Concepts

• December Market Performance: Historically a strong month for the TSX and S&P 500, often associated with a "Santa Claus rally."
• Canadian Bank Earnings: Anticipated to be positive due to strong fundamentals, despite a slower economic environment.
• Mortgage Market Stress: Stress test rates for mortgages originated in 2020-2021 were higher than current 5-year fixed rates, potentially alleviating some mortgage market stress.
• Loss Provisions: Expected to decrease for banks due to sound underlying economic fundamentals in Canada.
• Capital Markets: Increased trading activity in capital markets, driven by rising market trends, is expected to support bank earnings.
• Canadian Bank Index: Reached a record high on Friday, suggesting potential optimism.
• Canadian Economic Outlook: Characterized by below-trend economic growth and a "sluggish patch," but avoiding a recession.
• TSX Performance Drivers: Banks, gold, and certain companies have been key drivers of TSX performance.
• Future Market Outlook (2025-2026): Optimistic outlook for Canadian equities, with potential for new record highs, though growth rates may moderate.
• Active Management: Opportunities exist for active management to identify undervalued or underowned quality companies due to concentrated sector performance and rising valuations.
• Sector Opportunities: While specific sector preferences are difficult to pinpoint due to the heterogeneous nature of the TSX, attractive individual companies exist.
• Geographic Allocation: Not advocating for overweighting Canada geographically, but acknowledging solid opportunities.
• Fixed Income (Bonds): Currently underweight fixed income in a 60/40 portfolio, but emphasizing the importance of reviewing fixed income's role and understanding risk-reward, especially as equities have performed well.
• Risk Management: Advising clients to understand their risk tolerance and the risk associated with equity performance, as most financial plans do not target excessively high rates of return.

December Market Outlook and Bank Earnings

The upcoming week is significant due to bank earnings reports, a crucial event for Canadian investors. December is historically a strong month for stocks, often referred to as the "Santa Claus rally," where investor exuberance and holiday cheer can drive markets higher.

Key Points on Bank Earnings:

• Positive Outlook: The co-chief strategist at Manulife, Kevin Hedland, expresses a positive outlook on the upcoming quarterly earnings announcements for Canadian banks.
• Strong Fundamentals: Underlying economic fundamentals in Canada are considered strong, supporting the banks.
• Mortgage Market: While interest rates have come down, potentially increasing risk in the mortgage market, mortgages originated in 2020 and 2021 had stress test rates higher than current 5-year fixed rates, which may alleviate some stress.
• Loss Provisions: Loss provisions are anticipated to decrease again, reflecting the sound economic fundamentals.
• Capital Markets Impact: Banks with exposure to capital markets are expected to perform well, as increased trading activity due to rising markets supports these business lines.

Canadian Economic Environment and Bank Valuations

Despite the positive outlook for banks, the broader Canadian economy is experiencing a "soft patch" with growth below 1% and below-trend economic growth. However, the economy is currently avoiding a recession.

Key Points on Economic Environment and Bank Valuations:

• Sluggish Economy: The economy is in a sluggish phase with some inherent risks.
• Bank Performance Drivers: Banks have been a primary driver of the TSX's performance this year, alongside gold and other specific companies.
• Valuation and Sustainability: The Canadian bank index recently hit a record high, suggesting some optimism. While there might be some sustainability for further bank stock price increases, it's unlikely to be at the same pace seen previously. No immediate trouble is foreseen for current bank stock prices.

Broad Outlook for Canadian Markets (Closing out 2025 and into 2026)

The outlook for Canadian markets remains optimistic, with the potential for the TSX to reach new record highs.

Key Points on Market Outlook:

• Continued Optimism: A constructive outlook for the TSX into 2025 and even 2026.
• Solid Fundamentals: Companies are generally in good shape, despite pockets of economic weakness.
• Moderating Growth: The rate of change and growth may not be as high as previously experienced.
• No Alarming Issues: In the near term, there are no significant alarming issues that would warrant avoiding the TSX.
• Opportunity for Active Management: With rising valuations and concentrated drivers of returns in certain sectors and companies, there is an opportunity for active management to identify dislocations in quality companies that may be underowned or undervalued.

Sector Opportunities and Geographic Allocation

Identifying specific sectors that are unfairly neglected is challenging due to the heterogeneous nature of the TSX. However, attractive individual companies exist.

Key Points on Sectors and Geography:

• Attractive Companies: While specific sector preferences are hard to define, there are attractive companies within the Canadian market.
• Geographic Footprint: The recommendation is not to overweight Canada geographically, but solid opportunities remain.
• Portfolio Manager Findings: Canadian equity portfolio managers are still finding great opportunities that the market may not have fully recognized or priced in yet.

Fixed Income (Bonds) and Risk Management

Manulife's portfolio managers are currently underweight fixed income in a 60/40 portfolio strategy, but only slightly.

Key Points on Fixed Income and Risk:

• Underweight Fixed Income: A very slight underweight to fixed income, with no strong reason to increase it above a neutral weight.
• Equity Attractiveness: Equities still hold some attractiveness.
• Importance of Bonds: Investors who have avoided fixed income due to strong equity performance over the past few years should review their portfolios.
• Risk-Reward Assessment: It is crucial to understand the risk-reward at this point in the market cycle.
• Risk in Equities: When equities perform well, investors may be taking on more risk than they realize.
• Realistic Return Targets: Most clients do not have 15-20% target rates of return in their financial plans, emphasizing the need for realistic expectations and risk management.

Conclusion

The Canadian market is poised for a strong close to the year, with banks expected to report solid earnings driven by robust fundamentals and favorable capital market conditions. While the economy is in a sluggish phase, a recession is being avoided. The outlook for Canadian equities remains optimistic, with potential for new highs, though growth rates may moderate. Active management is highlighted as a strategy to capitalize on potential market dislocations. Investors are advised to carefully review their fixed income allocations and understand the risk-reward profile of their portfolios, particularly in light of strong equity performance.