Making sense of the markets this week: January 29, 2023

Have we reached peak interest rates?

On Wednesday, the Bank of Canada (BoC) announced that it would raise its key lending rate to 4.5%. The 0.25% increase wasn’t a surprise, and it is the BoC’s eighth meeting in a row where it raised the benchmark rate. Given the lower-than-expected inflation numbers reported last week, this moderate decision seems like the logical response.

The noteworthy part of the Bank of Canada’s rate-hike announcement on Wednesday, however, is the statement from Tiff Macklem, the BoC’s governor: “With today’s modest increase, we expect to pause rate hikes while we assess the impacts of the substantial monetary policy tightening already undertaken.” 

Canada is the first G10 economy to hint at pausing rate hikes for the foreseeable future. Indeed, 55% of economists polled by Refinitiv expected this to be the last rate hike in 2023.

Of course, like any good “on the one hand… and on the other hand” economist, Macklem was quick to stipulate: “To be clear, this is a conditional pause […] If we need to do more to get inflation to the 2% target, we will.”

The pause in rising rates comes none too soon for variable-mortgage holders, who will see another $21 per $100,000 in mortgage debt added to their monthly payments going forward.

Many continue to hope for the world’s central banks to get the monetary “shower dial” turned to a Goldilocks temperature that forces consumers to spend less—but is also low enough that it destroys a minimal amount of jobs.

CNR profits reveal that it’s still a gravy train

Canadian National Railway (CNR/TSX) announced its fourth-quarter earnings on Tuesday. (Values in this section are in Canadian dollars.) With earnings per share (EPS) at $2.10, it topped expectations of $2.09. Overall revenues were reported at $4.54 billion, which also offered a slight increase versus the $4.51 billion predicted. The stock was up 0.36% on the day.

Clearly, the widely prognosticated earnings recession hasn’t come for the rail yards yet, as those EPS numbers represent a 23% year-over-year increase. CNR’s board approved an 8% dividend increase, marking its 27th consecutive year of dividend hikes.  

As I anticipated when I wrote about Canadian railway stocks on MillionDollarJourney.com, CNR’s duopoly status has allowed it to efficiently pass cost increases along to customers. Tuesday’s announcement revealed that while operating expenses for the quarter were up 20% mainly due to higher fuel costs, management simply added a fuel surcharge that helped raise revenues by 21%.

The weaker Canadian dollar was also reported to be a factor for CNR’s increased revenues. If one believes oil prices aren’t going through the roof again and that the Canadian central bank is going to be less hawkish than its American counterpart, then this price advantage may remain durable throughout 2023.

CNR is currently trading at a price-to-earnings (P/E) ratio of 23.54 and has a dividend yield of 1.77%. The question for stock pickers isn’t whether CNR is going to be a profitable company (it’s pretty obvious that it will be), but whether it is worth paying for those future cash flows at these fairly lofty valuation levels. The answer is less clear as investors appear willing to pay a premium for stability at the moment.

Will earnings stop big tech’s bleeding?

Ever since investors realized the days of low interest from the pandemic are behind them, they’ve punished the share prices of tech companies.

Some of the first 2023 earnings results revealed that many of the most pessimistic scenarios appear to be off the table for now. (All numbers in this section are in U.S. currency.)

IBM (IBM/NYSE): Earnings per share of $3.60 (versus $3.60 predicted) and revenues of $16.69 billion (versus $16.40 billion predicted)

Tesla (TSLA/NASDAQ): Earnings per share of $1.19 (versus $1.13 predicted) and revenues of $24.32 billion (versus $24.16 billion predicted)

Microsoft (MSFT/NASDAQ): Earnings per share of $2.32 (versus $2.29 predicted) and revenues of $52.75 billion (versus $52.94 billion predicted)

Of course, Tesla and its celebrity founder and CEO, Elon Musk, took the top headlines again with a significant earnings beat. Tesla shares were up 5% in after-hours trading on Wednesday, and Musk stated the company could produce up to two million cars in 2023 barring a “friggin’ force majeure thing that happens somewhere on Earth.” As always with Mr. Musk, he is nothing if not entertaining.  

It wasn’t all “good news” for Tesla, though, as the electric vehicle (EV) company reported shrinking gross margins of 25.9%—the lowest margins for Tesla in 15 months. Musk suggests the price cuts are working, saying: “Thus far in January we’ve seen the strongest orders year-to-date than ever in our history. We’re currently seeing orders of almost twice the rate of production.”

As always, it’s not whether Tesla is an incredibly innovative company that will one day sell a lot of cars—that much has been proven already. Sure, it’s a good company, but the question is (like with CNR, above): Is it worth what people are now paying for it? You can refer back to “Making sense of the markets this week: January 8, 2023” for more on that.

IBM and Microsoft posted results essentially in line with expectations. While Microsoft beat on quarterly earnings, it downgraded its forecasted revenues from its Azure cloud service. Meanwhile, IBM is doing its best to control costs by cutting 3,900 jobs, 1.5% of its total workforce. 

Canadian productivity issues, the new Bill Morneau 

Gone is the old Bill Morneau—the one who had “The Honourable” in front of his name. You know, the minister who went after small businesses and proudly announced “budget treats” in order to distract from political scandals.

In his place is the new CIBC board member and budget hawk Bill Morneau. They may look the same, but do they ever sound different.

In his new book, Where To From Here: A Path To Canadian Prosperity (ECW Press, January 2023), the former finance minister advocates for several priorities and policies that have been largely ignored by the Trudeau Government. These include reversing the Harper government’s gradual raising of the OAS age from 65 to 67, making our business more internationally competitive, and creating a more focused economic growth agenda.

He says in a recent interview: “Now I want to start a conversation on the serious economic issues facing the country, at a pivotal time for Canadian business.” One might assume the time to start a conversation about serious economic issues was when an individual was the minister responsible for economic issues, but I digress. 

The truth is: Canada has a major problem when it comes to increasing productivity throughout our economy. And this is everyone’s problem, because without per-person productivity going up, we can’t afford better health care, better education, better social welfare programs—you know, all the stuff most Canadians want our government to provide at high levels.

Morneau writes in his book: 

“From the end of the Second World War to the mid-1970s, few countries exceeded Canada’s rate of economic growth. As one measure, the weekly earnings of Canadians grew at an average of 2.54 per cent annually over that period after accounting for inflation, more than doubling our earned income. Pretty impressive, but from 1982 to 2019, our country’s real GDP rose an average of just 1.3 per cent annually, which is not impressive at all.”

Perhaps the most depressing thing about this productivity issue (which has been getting worse for years, btw) is that it is a very nuanced topic. And it’s one that’s not easy to explain. 

Increasing competition by opening up our markets to foreign competitors, and finally doing away with the ridiculous provincial trade barriers that have been stifling efficiency gains for decades, would be great long-term moves. Of course, those changes would create short-term economic losses, and the folks experiencing those losses would be very vocal. Hence, the political Catch-22.

Instead of focusing on the communication of difficult-but-important productivity policies in the areas of corporate taxation, efficient regulation, foreign investment, infrastructure and free trade, what we get instead are sugary announcements about billions of dollars in supercluster investment that don’t really increase overall productivity. 

What is often missed in these announcements is that these billions of dollars in “investments” are actually coming from taxpayers. If you’re taking tax money from productive companies in order to give it away—ahem—to “invest” about $1 million for every 14 jobs “created,” then it’s not a very good economic policy.  

Given that Canada’s gross domestic product GDP per member of the labour force is 41.8% lower than the U.S.’s and 36.1% lower than France’s, it is clear there’s room for improvement. Our relatively low productivity rate is also a driver of inflationary pressures. Canada has so many advantages when it comes to geography, migration policy and political/judicial infrastructure. Now we just need to listen to the new Bill Morneau (the one with “former” in front of his name) when he says that he is finally ready to start a conversation about “serious economic issues.”

Kyle Prevost is a financial educator, author and speaker. When he’s not on a basketball court or in a boxing ring trying to recapture his youth, you can find him helping Canadians with their finances over at MillionDollarJourney.com and the Canadian Financial Summit.

About Kyle Prevost

Kyle Prevost is a financial educator, author and speaker. He is also the creator of 4 Steps to a Worry-Free Retirement, Canada’s DIY retirement planning course.

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