Rate cuts to boost consumer discretionary stocks

Bargain prices won’t last long

Recent announcements by the U.S. Federal Reserve, Bank of Canada, Bank of England, and the Swiss National Bank (SNB) all showed that central banks are preparing to cut short-term interest rates later this year. In fact, SNB has already cut rates to 1.5% from 1.75%. The statements by the other central bank chiefs made it plain that they were not unduly influenced by the uptick in CPI and PPI in the first two months of the year.

The U.S. Federal Open Market Committee (FOMC) members’ expectation of where interest rates will be in a year’s time (the so-called dot plot, which is the method of tracking members’ forecasts) still shows three 25 basis point cuts by the end of 2024, bringing rates down to 4.5%-4.75%.

While holding rates unchanged for now, the Bank of Canada still expects that “the conditions for rate cuts should materialize over the course of this year.”

Given that the yield curve remains inverted, with short-term rates (5%-5.5%) being higher than long term (10-year) rates (4.3% in the U.S. and 3.5% in Canada) for the last 18 months, the continued strength in many sectors of the North American economy has convinced observers that the fabled soft landing is the most likely outcome. This despite the inverted yield curve having successfully forecast recessions for the last 50 years.

Given the likelihood of at least an economic slowdown occurring this year, the fact that major stock indexes are hitting all-time highs seems paradoxical. The S&P 500 is at record highs. The Japanese Nikkei 225 has finally exceeded its 1989 high and the Bank of Japan raised interest rates for the first time in 17 years. Even the Canadian and U.K. markets, held back by their high exposure to financials, energy, and materials and low exposure to desirable technology stocks, are nearing their previous all-time highs.

While the stock index valuations are not as excessive as at the height of the technology bubble in 1999-2000, thanks to the enormous profitability of the so-called Magnificent Seven large-cap technology stocks, nevertheless they are at levels that, historically, have yielded disappointing returns over the following 10 years (2%-4% annually).

In addition to the stock markets, other assets such as cryptocurrency and gold have also been hitting new highs, with Bitcoin exceeding US$72,000 and gold topping US$2,200 an oz. This indicates that the central banks’ willingness to consider cutting interest rates means financial conditions will loosen and inflation may yet make a comeback.

Investors should now be looking at sectors that have been lagging due to the regime of high interest rates. One of these is the consumer discretionary sector where many companies have been reporting disappointing earnings and revenues, putting them into bargain-price territory.

One of the biggest of these is general retailer Canadian Tire Corp. Its stock is no higher than it was five years ago while the company continues to expand its store network.

Canadian Tire Corp.

Canadian Tire Corporation (TSX: CTC.A) is one of Canada’s leading retail brands, with 100% name recognition. It is estimated that 80+% of Canadians shop at Canadian Tire (CTC) each year. The company had delivered same store sales growth (SSSG) at stores open for at least a year for the decade up to 2023.

CTC was considered an essential retailer during the pandemic and benefited from the growth in sales of home improvement and outdoor activities. Having purchased several well-regarded brands, such as winter wear producer Helle Hansen and hockey equipment maker Sherwood, which Chicago Blackhawks hockey star Connor Bedard uses, CTC is aiming to increase its share of own-label brands to 43% from 38% over the five years from 2022.

With CTC selling at approximately the same price as five years ago (down 7% before dividends), all short-term bad news seems reflected in the price. Operating income is down by one third, to $1.28 billion in 2023, largely due to the weak seasonal sales. Provisions for credit losses (PCLs) on its credit card portfolio increased 33% (its fourth-quarter past due receivables climbed to 3.6% from 3.3%). However, management anticipates these are short-term in nature.

While its capital expenditure program in 2024 has been reduced to $475-$525 million from the $550-$600 million forecast a few months ago, falling interest rates should enable a recovery in sales. The “Better Connected” strategy the company announced in March 2022, anticipated $3.4 billion over the four-year program, on store upgrades, additional warehouse construction, new product launches, and the expansion of its Triangle loyalty program, of which $1.4 billion has been spent so far.

CTC has raised its dividend every year for the last decade, to a current $7 a year from $2. Most recently it increased its dividend by $1.75 per share (1.1%) this year, giving a yield equivalent to 5.3%.

CTC is for investors looking for a reasonable and sustainable dividend yield from one of Canada’s leading and most successful retailers, whose stock price is temporarily depressed.

Gavin Graham is a veteran financial analyst, money manager, formerly Chief Investment Officer of BMO Financial, and a specialist in international investing, with over 35 years’ experience in global investment management.

Notes and Disclaimer

The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.

The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

Image: iStock.com/shironosov